Tuesday, March 12, 2013

Ecce Resicum

Good news! The Dow is at record highs, companies are merging and acquiring more, and lots of people were hired last month!

Though, there is more. Europe is still stuck on self-flagellation. Tremors in the Middle East continue; you could make points about China and Japan, too. Plus, Washington’s only focus is on innovating the harm it inflicts on the country. Professionals, that lot.

The good news is actually strange news…from a macroscopic perspective, you might say, Eh, same ‘ol situation, no? So – what the devil is going on?

I haven’t the slightest clue! But I’ve heard recently that tail risk is down, and that investors are back in Risk-On Mode…

Jeez. Have we resorted to so little in the way of analysis? Investors have shifted to a risk-on mentality? Uh, I hope we can do better than: Something went up, so something turned on. Let’s just refuse these cheap observations; much too tedious, and deeply flawed. (And if point is about correlation, say that!)

Unfortunately, the flaw runs deep. Speaking of Risk On/Risk Off doesn’t just waste time by saying nothing. It also mangles our understanding of the process of taking risks. I’ll tell you why.

But first, humble and patient reader, allow me to slake my appetite for a meditation on risk. It'll be something of a scenic stroll, I promise.

*     *     *     *

What is risk? The potential for harm, you say; the imminence of danger. I agree. Risk implies something bad might happen. How about this: risk, then, implies existence, because it entails something is there to be harmed. It could be your body, or it could be your bank account. Either way, risk means phenomena.

In a crude but fundamental way, life itself, that blip of light in the infinite dark, is simply exposure to death. Turns out the potential to die is no mere attribute. It is life, defined. And so: Life is risk. Similarly (but not too similarly, I hope you’ll agree), money is risk. Money in all forms carries risk; the only riskless asset is one that does not exist.

Okay, I agree, that’s not so profound. My hope is to emphasize that all of life is dealing with risk, and, in finance, every asset presents risk. We don’t choose to deal with risk. By living, we simply must.
Well. Broadly, that effort is twofold: First, we must evaluate riskiness – the extent of danger or potential harm (often estimated probabilistically). Second, we determine our risk appetite – how much of that danger we fancy.

Step one is extremely difficult to do accurately, in general life and in finance. And step two requires some reflection. But conflating these two operations is not difficult to avoid, and yet, alas, it is a ubiquitous mistake. Shall I bungee jump? Shall I buy some AAPL? Each question has two parts: how much risk is there? How much do I want?

Anyway, let’s return to the cheap observation from above – that Investors are demonstrating a risk-on mentality in 2013. ­What does this tell us about how investors are taking risks? Not much.

Risk-on sounds as though investors demand more risk. That makes sense, and is perhaps likely – central banks, at least, have made enormous effort to encourage investors to take more risk. But appreciating equities could also imply investors estimate risk is lower, while maintaining the same risk appetite.

And, of course, the reality is probably some blend of the two. But the difference is significant enough: demand for US equities driven by demand for higher risk suggests a different vote of confidence than if equities appreciate because they are estimated to be safer.

The point is simply that Risk-On/Risk-Off observations ignore this distinction. And the distinction is important: are investors becoming more frenzied, or do equities seem safer?

*     *     *     *

If I were nerdy and you were unlucky, I'd even say the two steps are dialectical. The operation is self-influencing: because step one (how much risk does a given opportunity present?) will always carry some uncertainty, step two (how much risk do I want?) must incorporate the confidence in step one’s answer. If you think bungee jumping or buying AAPL carries moderate risk, and you demand moderate risk, you might yet move on because your confidence in your estimation is low.

This is obvious, and I apologize for boring you. Among many others, only louder, Nassim Taleb's been inveighing against the confidence risk managers have in their risk estimations. That hubris is a frightening problem. Many people make the mistake before arriving at the office, simply by thinking they are measuring as opposed to estimating risk.

Risk estimation, which is usually done probabilistically, often creates the unfortunate chimera of precision. That is a misunderstanding of probability. I’m no true expert (my skepticism notwithstanding), but I’ve studied and practiced enough to see that probabilities are expected (estimated) frequencies of possible events. Although probability functions provide exact numbers, the entire effort behind probability mustn’t be forgotten: it is a stab in the dark - though an informed, rigorous one – no matter what Nate Silver says, because it introduces parameters to reality. That’s the only way it works – and works can only ever mean, at maximum, moving from total darkness to the penumbra. Probability theory works especially well in games (black jack, baseball) because the "reality" is already confined within only a few parameters (a deck of cards and the number 21; a hit or a strike, to name four). For more on this point and other marvelous arguments, I encourage an hour listening to Cathy O'Neil on EconTalk, and then perusing her blog. One finds oneself ululating.

There is much more to say – and fortunately for you, more eloquent and seasoned people have done so.
Let’s end this saga with the following irony. Taleb’s proposal for dealing with lack of confidence in risk estimations is to allocate investments following a barbell strategy. Put a big chunk (the majority) on the safest end of the spectrum, and a minority portion to the riskiest end of the spectrum. This tactic stands in opposition to the belief that allocation should be concentrated in moderate risks. In that case, Taleb thinks, you end up picking up pennies in front of a steamroller. You can only have so much upside, while you'll always hear the susurrus of potential downfall in every shadow, as so much depends on the accuracy of your risk estimation.

Fair enough. The point is to minimize exposure to risk estimation errors. But is his the logical conclusion? Allow me to adumbrate Taleb’s argument:
  • Minimize risk estimation error.
  • The smaller the probability, the greater the estimation error is likely to be.
  • So, Minimize the risks with smallest probabilities.

Wait a tick! We should all be investing in the biggest risks, where the probability of harm is large and therefore easier to correctly estimate!

I admit to finding that funny. You might not, but then, you have a life, and I have a blog. Of course, this is an oversimplification of Taleb’s point. The argument above must be balanced with other constraints.

But there is a kernel of truth. As a rule of thumb among others, this says invest according to a function of ignorance. There are small arbitrage opportunities that come with tough-to-estimate risk; picking up pennies ahead of a steamroller. For the prescient investor, this is manageable. For the ignorant one, this is a dangerous method. Better, perhaps, to go for the high reward, higher risk opportunities – for in those cases, the risks are easier to see.

*     *     *     *

And what about your life outside investing? Well, the same applies – take more risk, and you’ll live more life! Just don’t die.

Thursday, January 24, 2013

The Beautiful and Damned

Well thank heavens for Davos. Between the crass kerfuffle over Herbalife and Apple’s swan dive, it really has been an awfully uncomfortable start to the year for billionaires.

Allow them some time surrounded by insular snow to celebrate and convince themselves of their stratospheric significance: these are, let's not forget, the “Leaders of the World,” who, upon reaching the very summit of mankind’s mountainous achievement, strive to extended farther still. And obviously this consortium of achievement may only be physically captured by those most peaked of peaks, similarly stretching to the realm of Gods: the Swiss Alps.

That, at least, is what they tell themselves, seated together, in the comfortable and familiar gleam of a power-point projector. And who can blame them? We all need a social support network. You’re in a book club, I play on a tennis team, and Jose is in a weight-loss group. Same idea.

I wonder if Bill Ackman is there. Remember him? He’s the one who put a billion dollars on the short side of Herbalife stock. After delivering a presentation long enough to fulfill credits for a Bachelor’s Degree, the stock price tanked. But then another billionaire hedgie (a Mr. Dan Loeb) got on the other side of the stock. And his announcement got the stock price rising like a winter swell off third point in Malibu. Now you can sell HLF where it was pre-Ackmanization.

Luckily for us, the salty-Aussie John Hempton has gone to Queens to see what the real fuss is about. He finds mostly fat, mostly Hispanic, mostly male people congregating to lose weight drinking protein shakes, all behind opaque, lime-green windows. Everyone needs some exclusivity.

Anyway, JH puts it so:

What this has (deservedly) become is the story about how Bill Ackman can be so wrong. He spent (by his own admission) a year and a half analysing this company and his thesis can be falsified by visiting a few clubs in his home city. Bill Ackman's thesis is the most easily falsified bear-thesis I have seen from a major hedge fund ever.

You have to wonder how this happened. So I am going to tell you:

Bill Ackman a Harvard educated (magna cum laude) billionaire New York hedge fund manager bet over a billion dollars on a short position (imperilling his fund and his reputation) without checking the facts.

And he did not check the facts because he was so rigid with a misplaced silver spoon that he could not stoop to sit on a subway for thirty minutes and talk with poor people for ninety minutes

A trifle too churlish for my taste. Ackman thinks the FCC should get involved, because he says Herbalife is a fraudulent pyramid scheme. He also says that if the FCC does not act, the stock will still collapse: soon, people will stop signing up as a result of realizing the business opportunity is bogus.

But as JH has found, people sign up for the discounted prices in most cases. Seems like they will continue that as long as they are losing weight together. People consistently make irrational purchases all the time – and even considering the bad business opportunity, one might recall the roaring apetite for lotto tickets...

This tale reminds me of The Beautiful and Damned, of which the first thing to note is the missing “the” – The Beautiful and “The” Damned would imply two separate groups. There’s just one group here: those who are beautiful as well as damned.

The title, tragically, applies to all parties. First up is Mr. Looking-Quite-Silly-Billy Ackman: After spending years of his life (Seriously. People do this.) pouring over all sorts of numbers describing folks that pay too much for a protein shake, he finally surmises, from high in the sky above Seventh Avenue, that it all must be an illegal pyramid. No way are people just doing this for the social support! What a rip-off! Oh, how much is that Davos ticket? Yea, that’s fine.

Then we have the poor and marginalized, investing hard-earned cash into crappy protein shakes, a long-shot business opportunity, and the accompanying community. The key here is this: AA, Overeaters Anonymous (Yup.) – those are free, non-profit groups. No share buy-backs and dividends around AA…

But (stunted egos, shedded pounds, and a bullshit business opportunity notwithstanding) a mention of the biggest losers has not been heard.

It’s those poor ol’  soon to be retirees, as usual, whose pension funds (there must be several) are mercifully paying both Ackman and Loeb exorbitant management fees as they go mano-a-mano, and will pay the winner a gargantuan profit fee for profits that will be offset from the other’s losses. A bummer, that.

Admittedly, this isn’t exactly Hector v. Achilles at Troy’s walls. But where else have such lauded experts stood exactly opposed to each other? And while facing humiliation worth a billion dollars?

Experts disagree all the time; its part of what it means to be expert, you could say. But not like this. Here we have two men whose investing records frequently cause drooling and jealous moans at conferences and board meetings. Yet with every resource you can imagine, and with years of analysis – the outcome? Exactly opposite.

So who is really being duped?

The story is far from over. Herbalife’s next earnings report will be a fun time; who knows? maybe Ackman’s presentation caused a dent – if growth is below expectations, there could be a spook.

I wouldn’t bet on it, though. Let’s not forget the refined observation (even if we’ve forgotton its maker): Great loads to mortal men allotted be – but of all packs, no pack like poverty.

Thursday, January 3, 2013

Is Steve Jobs Really Gone??

The always honest and diligent Brooklyn Investor has a new post. He’s (even more) bearish on AAPL. After studying Polaroid’s destiny post-Edwin Land, and after reading Walter Isaacson’s detailed descriptions of Steve Jobs, our man in Brooklyn is convinced that Apple won’t be able to continue its success. The “Key Man Risk” is being fully realized.

You see, often the most successful companies are built upon (and therefore existentially depend on) the genius of a single person. Apple has other very smart people – Tim Cook, the operator-guru, and Sir Jon Ive, of industrial design nobility – but they need Jobs to tell them what to do.

Fair enough.

But I spot a flaw in TBI’s logic. Let’s take his premise for granted – I think he’s mostly right, anyway: Jobs was a unique genius; a vital component to Apple’s success.

Now consider two other important facts: Jobs knew he would die prematurely, and he also knew, as TBI repeats, that Tim Cook is Not A Product Guy.

Putting these two facts together, what do we find?

I think the only logical conclusion is that Steve Jobs must have done everything he could think of (quite the arsenal, you’ll admit) to ensure his influence would live on as long and as toweringly as possible. 
Remember, the guy was megalomaniacal about Apple, too.

SO: If there were ever an award for systematically diminishing Key Man Risk, wouldn’t you have to bet on Steve Jobs receiving it? (An aside: Ray Dalio is probably up there too – but consider that he is looking to retire, and we all know that passion like his (and Jobs’) never really retires. Jobs was facing death – nothing half-way about that.)

Put differently: it seems logically inconsistent to assert the vital brilliance of Steve Jobs, and then assert that he was not able to minimize his own departure.

OF COURSE, I’m not saying that Apple will go on forever, as it would have if Steve Jobs were still around. Hey, times are always a’changin – even Steve Jobs would never be able to predict what the world will look like next decade.

But a few years?

You don’t think he did everything he could to come up with Apple’s Next Big Thing? And the one after that?? And that he didn’t get Cook and Ive and whomever else in a room, saying, “Guys, look, here’s how the next ten years go”??

Here is how I think of it:

Steve Jobs went from living to dead in a moment. But his influence on Apple is different; it must have a kind of half-life; it diminishes by a decay function. I don’t think Apple makes it without Steve Jobs – but his plans and ideas will still lead the company for a while.

How long is a while? Well, it’s been two years, and I’d guess, conservatively, that Jobs still had one Big Idea up his sleeve… We haven’t seen that yet.

Just keep in mind: Steve Jobs influence on Apple has serious momentum. It’s decaying, and exponentially so – but it is still there. And that influence, even at 90% – even at 50% – is significant.

I wouldn’t count him out quite yet.

Sunday, December 30, 2012

A Hedge Fund, Not a Hedge Fund!

Hedge funds, together, are “Going Nowhere Fast,” says the Economist. Sound the alarms – it’s been “another lousy year, to cap a disappointing decade.” Well, I guess it depends whom you ask: There’s a bunch of people high above New York City streets chary of change – has there been another group paid so much for so little?

And of course, the Economist points out, some hedge funds have done very well. “The top docile of managers has served up returns of over 30% in the past year.” Although, you’ll need more than the newspaper’s well wishes choosing which, of the 8,000 available funds, will be in the top docile.

But anyway, what’s all this about? The geniuses are failing? What else is new?

As usual, the problems are vast – but we could all start with a simple issue: nomenclature. People are grouping together funds that oughtn’t be in the same group, and evaluating them together, by the same standards. I’m not talking about “Event Driven” versus “Fixed Income Relative Value Arbitrage” – God no; I do actually hope you will be awake by the end of this post (I have my doubts). The problem is even simpler. People can’t answer the question: What is the point of a hedge fund? And that, my friends, is crucial to the questions Why invest? and At what price?

By name, at least, a hedge fund should be hedged, which is to say that the downside is insured. There is a cost to that, which, very roughly, comes from the upside. The approach is conservative; conservation of capital is the first priority. On this premise alone, one would think the portion of an average (conservative) portfolio consisting of hedge funds would be the majority.

Yet hedge funds mean more than the name suggests. People running the top funds are among the richest people in the world, and they often have PhDs; two things that can only mean genius. That point becomes utterly unequivocal with all that complex math and law… The people running the funds are most convinced: their strategies are so genius as to be kept top-secret – unknown, in many cases, even to their clients. (In a kind of, what, religo-cultish fundamentalism, you might say).

To emphasize the observation, consider two fine examples: Bernie Madoff, and LTCM. Both went bust; the first was top-secret enough to commit elephantine fraud, and the second had enough Nobel’s to justify leverage of, like, 50:1 on bets that blew up.

Hedge funds have an alter ego: this sort takes big risks, which rely on intelligence nearing clairvoyance, and remains secret to you – you, who merely give them their money.

Now, the crucial part.

Until the past few years, I dunno, to about 2006, hedge funds were mostly identified as opaque, high-risk vehicles, which many of them are. When (conservative) Pensions invested in hedge funds, the allocation was small because of the risk – both operationally (opacity) and instrumentally (type and quantity of securities and leverage). Also – this is decisive – hedge fund managers were compensated the so-called two and twenty. That compensation reflected the risk: small allocations meant the management fee usually was second fiddle: twenty percent of profit is the main game.

Today, hedge funds are viewed slightly differently. You could say the “Hedge” in hedge fund is making a comeback – many, at least, are more conservative. 2008 was tough on hedge funds – but not as tough as it was on equity markets. People were hedged (though in most cases not enough). And from 1994 to 2007 hedge funds returned only a trifle more than the S&P – but with half the volatility.

Mostly, hedge funds are becoming far more transparent, often more specialized, and much more numerous. They cater to what is now their biggest customer: Pensions. And in so doing, as a group, hedge funds have inched closer to the conservative identity. Which is why “Hedge funds now manage $2.2 trillion in assets, up fourfold since 2000,” as the Economist reports.

Yet despite not beating inflation, they still charge exorbitant fees (which, despite slightly lower “negotiated” fees, have probably and excruciatingly amounted to more than has been returned to clients), and still tout their genius. Well, here lies the schizophrenia.

Pensions pay for amazing geniuses to generate mundane security. To (begin to) fix the problem, I think we need to change the nomenclature so that it reflects different general approaches.

But first, an aside:

Nassim Taleb explains the (old, wise) idea of a barbell, or bimodal, strategy as it applies to investments as so: The lion’s share should be allocated extremely conservatively, while the small remaining proportion (perhaps ten percent) should be allocated to the risky business.

That way, roughly ninety percent of the portfolio is (actually) safe, while, therefore, at most ten percent may be lost and much more may be gained.

OkayOkayOkay – I here the shouts and cries to diversify with proper weightings. Let me respond with what hopefully will become a post of its own: that all depends on forecasting correlations, particularly when they spike together, which is, um, impossible. (Just note that when times are best, correlations are low, which at best means your chugging along, while at worst, correlations spike, and your whole portfolio is down the tube…it’s the equivalent of the field goal kicker’s plight: your best possible performance is “Hey, good, you did your job” and at worst is, “WE’RE GUNNA HANG YOU!”

Anyhow, assume the barbell strategy. In that case, the larger allocation is to the ultra safe managers – those who buy inflation protected treasuries, perhaps, and constantly purchase puts on everything. Safe, slow goings.

On the other side, you want the LTCM like people. Go Ahead – use lots of leverage on Greek bonds, the Facebook IPO, RIMM at six bucks, or a ton of OTM calls.

Right, so: Whatever your strategy, my hope is to distinguish conservative funds from riskier ones. Lots of difficulty there – but it’s a good start, I think, to have a different names. The conservative side should be called hedge funds, while the risky side could be called….what? WAIT, we already have a name – but unfortunately its been contained to a single domain. Time to break it free!

Venture Funds! Venture – which comes from adventure – means a risky or daring undertaking. Bingo.

That way, Hedge Funds: Going Nowhere Fast might one day bring sighs of relief.

Thursday, August 9, 2012

Ego / Work

This could help:

Notoriously, Ray Dalio insists his employees leave their egos at home when they come to work at Bridgewater. That way, criticism is more efficient: no need to wrap it in passively aggressive pseudo-pleasantries. Productivity rises. How nice.

The benefit grows as the culture becomes ingrained. It’s not cultish (well, it is – just no more than other corporations) – nor is it novel; Socrates perfected the method thousands of years ago. (Though he with style:  a bottle of wine, and in the nude…)

Well, Dalio has it mostly correct, I’d say. It’s crucial to avoid the touchy-feely circumnavigations of passive aggression and stupid niceties. But I don’t think that requires shrinking, deflating, and defeating the ego. Actually, to me it’s the opposite [CAUTION - I'm about to get preachy]:

Criticism should be taken and given straight-up because one has an ego – not in spite of it. Let’s not take ourselves so seriously. For example: I share an opinion with the team about the pitch book. The lead associate disagrees with me. She won’t sugarcoat her criticism – not because we’ve eradicated ego, but because my ego isn’t affected by her conflicting opinion. I (and not she) determine my ego and self-esteem.

Unfortunately, this blend of confidence and self-esteem is few and far between: most people desperately depend on others for self-esteem. In those cases, criticism is only possible when wrapped in ridiculous, time consuming, and confusing BS, for fear of destroying someone’s day – or worse.

Lots of wasted time and opaque communication would be avoided if people weren’t so sensitive about their opinions at work. Look – its fine and good to care about what you do, and to want to do a good job, and to hold strong opinions about what is a good job – but, please, do not be offended if someone disagrees with those beliefs! Have some self-esteem! Have some ego – and don’t care! Better still, have some ego and humility: don’t be offended, and politely consider the alternative.

One should not leave ego at home. The better (easier going, less take-my-life-too-seriously) way is to remain unencumbered by judgments of your work. Do what you think is very best, please. That’s it - different from leaving the ego behind. I think ego provides confidence and humor, and extroversion too – all of which can be useful. But people tend, instead, to gain or lose self-esteem at the hands of their peers. Well, we won’t get any good work done if everyone is just trying to please everyone else…

Ego is also involved in another phenomenon I’d love to see in recession (but unfortunately is booming): Income inequality. The 1%. Too many successful people think, and even (shockingly) argue that they deserve every bit of the outsized paychecks they receive because they are more productive. Now, I’ll skip over the psychopathic premise embedded in this claim (that being productive gives you the right to promote suffering) and target the logical flaw. (By the by, I think some degree of inequality is not just necessary, as in logically unavoidable, in any human society, but also good. Too much, though, is ugly and, if uncontained, terminal. Where, exactly, that line is to be drawn is impossible to know precisely – but lemme put it this way: it’s a tiny spec in our rear-view mirror.)

Luck. Chance. Randomness. There is a good reason we say people with lots of money have “fortunes” – Fortuna’s kinder attention has fallen upon them. The point is simple, but profound (as is often the case): Far too much luck – chaotic randomness – goes into every instance of success everywhere, ever, for credit to be taken at another’s expense. Look, I’m all for ambition, and I do believe (and have experienced) that you can make your luck (well, make yourself available for a lucky event). But when people begin to regard their luck as the direct result of hard work other people weren’t willing to make, they are self-deceiving, and too serious. Quite grim, really.

This is concerning for all of us when its about wealth, in particular. Consider current income discrepancies in physical terms. The not-so-rare CEO making $40,000,000 a year (and there are people making 10 times that) gets 1,000 times what a person getting an about average $40,000 does. But does she eat 1,000 times more? Does she drive 1,000 Honda Accords? How about 10,000? Imagine something the person earning $40,000 buys, and then imagine 1,000 of them. And then 10,000. You likely won't be able to even imagine it. Again, there should be inequality, but it must be reasonable. And we past reasonable long ago; now we’re at completely insane.

I’ll end with this question:

When, in all (all) of human history have multiple oligarchs actually pleaded for higher taxes that do a better job targeting them?!? And – while sober!

Tuesday, July 10, 2012

Series Z Funding

Well, it’s already up over 15% over the past month. But being bullish on Facebook still seems novel (if not offensive). I’m buying with two considerations: that investing in FB is equivalent to a late-stage venture capital investment, and that FB is a great late-stage venture capital opportunity.

I know – venture capital investments never occur after an IPO. But think: at a market cap. around $65 billion (at one point it was $56 billion) we’re not far off valautions late-stage VCs were comfortable with pre-IPO. In early 2011 Goldman Sachs invested at a $50 billion valuation – I’d say they know what’s what. (Some say they know because they decide…)

But let’s zoom out further: Venture capital seeks potential for large gain to compensate for huge risk. I think FB stock has that profile: single-security risk and potential for large gains. Tougher though it is to outperform – now that FB is public, earnings must beat profit projections based on quotidian analysis; so earnings growth must be not only impressive but also surprising* – I think FB has room to scale.

WHAT?!? you ask.

Facebook still has room to scale. Your challenge to me, if you’ve kindly kept reading, must be: How is there room to scale when about a billion people have accounts (almost as many as is reasonably possible) and advertising revenue growth was adjusted downwards?!?

Well, you’d be right about that – users and advertising are not going to exponentially grow. And if advertising does, it will be projected and baked in, I’d guess, at least to a large extent. So – where is the growth?

Well, we’ve finally arrived at this post’s pith:

I do NOT think advertising will drive Facebook’s earnings growth. Yes, that flow will grow. But the beguiling bet is on Facebook monetizing their platform much more efficiently. Advertising earnings are formulaic and fairly simple to project. Shock earnings, I think, will come from different business.
Consider a convoluted analogy and comparison to Google:

Remember Dante’s Divine Comedy? Virgil leads Dante through the Inferno, Purgatorio, and, finally, to Paradiso. Along the way, he encounters, um, “residents” at each level, and those characters serve as examples from which Dante gleans how not to live (and who, exactly, sucks in Florence). Now, let’s distill the plot down to two mechanisms (insulting and neutering great literature along the way):

Virgil guides Dante; he helps him through the mess, pointing where to go and what to avoid. He provides incredible utility – though is not usually a direct source of the lessons learned.

Now, as opposed to Virgil, each “locale”– especially Inferno – offers its denizens’ example to Dante. 
From those characters, Dante learns and grows into the man that is at last able to reach Paradiso – that heaven so wondrous no collection of words can describe it (spare, of course, those making up a third of the Comedy).

Google is Virgil; Facebook is the “Locale”.

As Virgil does, Google leads us around the inferno-internet, consistently providing sage advice. Does Virgil make money? Yep! “Dante, here we have Popes and Clergymen of the fourth circle of Inferno, for the avaricious, presented by Barclays”…

Facebook, though, is Inferno itself – the very land where we do everything: leer at friends’ photos, pine for popular music, and hatch insidious strategies for…farming – anyway; everything it takes to shape us into the people ready for heaven…

By owning the Land, Facebook can charge rent...everywhere.

Put more plainly: Facebook is becoming the Landlord of the internet. Most sites – Google most explicitly – charge based on traffic passing through. But Facebook’s traffic hangs around. And does business. Spotify, Zynga, that startup I consulted last year – all businesses that rely and reside on Facebook’s land. It won’t be long till they pay rent.

Of course, I could be all wrong - maybe even most probably all wrong. But there's a chance I might be guessing right. The pop in that case is worth the while.

* See AAPL from end 2011 through April 2012 for the earnings surprise pop I’m hoping for.

Wednesday, June 13, 2012

Facebook: The Dark Swan

On the morning of May 18th, just before 11am, the world watched Nasdaq. Salivating over rumors – $70 in Europe – and watching minutes, seconds, and even milliseconds tick down on CNBC, muppets across the land tingled with hope. Even your Calm and Collected author felt his stomach lurch. Whoa. This is big. Fingers hovered over buy buttons everywhere. Clammy, cold, adrenaline-filled, fat, greedy fingers. FB – Yum.

Then the countdown clock finally showed 00:00:00...but – nothing. NOTHING. $45? Nope; nothing.

Nasdaq’s glitch was a Black Swan (a dark one too; still no one seems to see it). Totally unpredictable and extremely unlikely (though likelier than you’d think). They tested for months. But not enough!
In those thirty (was it 45?) minutes of Nothing, people became afraid. Adrenaline tapered off. Thoughts crept up; fear fertilized every what-if; a lush jungle of concern flourished in the buy-side Mind. Facebook’s IPO was the purest human-psyche play in a long time. It was either way up, or – plunge. 
But the glitch didn’t have to kill it. The real problem was the fear underbelly. Price and volume were at maximum. Quite a heavy load. It shouldn’t have been.

How could Morgan Stanley be so stupid? Even a bullet to the foot would have meant less pain and embarrassment: I’ve now seen it called Failbook as often as Facebook, and people are literally suing because Morgan Stanley stunk it up so bad.

Here's my scorecard - thoughtful, I hope you'll find, and surely uncontroversial, at least by recent standards:

Morgan Stanley, Loser:

To clear up, if I may be bold, an entertaining The EpicureanDealmaker/John Hempton debate: Morgan Stanley represented both buyer and seller, and owes “best efforts” to both. Which is obviously very difficult to do – but upsizing the issuance and raising the price to the highest end of an already elevated range unequivocally tilts the balance in Facebook’s favor. That much is clear to everyone – JH just thinks that’s ok because Morgan Stanley’s job is to get the highest possible price for the seller. But that’s blatantly not the case (thanks TED - and I’m quite shocked the tenaciously clever JH (still!) doesn’t see it); Morgan Stanley’s client base is also (and overwhelmingly) on the buy-side. Well, they’re upset – and although only partially justified (regarding “best efforts” they rightly say “WTF!?” But regarding “We’re owed a pop!” – please), there is a good reason people in customer service say the customer is always right…

Anyway: I can’t figure out what Morgan Stanley possibly thought through all this. They know which clients are most important; they also knew how prestigious leading a successful Facebook IPO would be. (Or did they forget “successful” in that sentence?) So how’d they manage a massive muck-up?
I’m left with one option: they could only have thought “Yea, we got this. We’ve oiled everyone up. We see lots of demand. We can’t think of a reason this thing doesn’t take off.” Know what? I think they were right in thinking so. BUT here’s where they went awry: when all things are “GO” for something this crucial, you really should say, Okay, lets take some redundant precautions. You say, Who knows? Maybe something happens, and people wake up not wanting Facebook as much. Sure the chances are slim – but just in case, lets go at $32.

As we all know so well, Wall Street never says Just In Case. Well, they do say: Oops.

Morgan Stanley pissed off lots of customers that pay over the long term. They managed to morph the most prestigious IPO into a honking, oozing forehead zit. But they do have one stoked client! Hey! …

Encouraging? Nope. Tempting though an affirmative answer is (Look – we get our issuers Rich!), I think the market says No. If I’m about to issue an IPO, chances are I want the thing to be well received, with good short-, medium-, and long-term prospects. I don’t want the folks who are my first public co-owners to squirm and squeal at the sight of my ticker (let alone projectile vomit). Do I risk dyspeptic public opinion for a few more bucks? For most companies, that’s an obvious N-O.

But not all companies...

Facebook, Winner:

Only one boss says Heck Yes!

I’m-CEO-Bitch Mark Z. He doesn’t give a fuck-all about a sickened public – in fact, peeps on a sick day average 14.8 hours on Facebook (I made that up). He made enough cash in a morning to make a polo-playing Arabian Prince double-take. Cash to buy the best up-and-comer startups, the best programming talent (from Google – thanks!), and, sure, a plane/yacht upgrade maybe, too. He doesn’t care about you and me: that’s why he made sure FB shares have about the same voting powers as the “Like” button.

Facebook sold part of itself at a massive valuation that didn’t even nearly withstand the broader market (to put it nicely). They sold much more than they originally thought feasible, and at a much higher price (and revised down earnings estimates!). If that doesn’t sound like a sweet deal, nothing does.

And, so:

Fascinating – and frightening – was Morgan Stanley’s push for the best possible outcome. I’m convinced the bankers probably didn’t think there was much risk; they probably thought they were satisfying only the fringe of fantastic demand. They might have been correct without the Nasdaq dark swan. But they didn’t prepare for an outlier. They never do.

Morgan Stanley lost badly; Facebook won outright. Quickly, lets note that Silicon Valley just man-handled Wall Street. Throttled ‘em. The Valley is competitive, but in a geek way; it really is friendly – but fiercely savvy, too.

As for the buy-side:

I bet (literally) patience will pay those who didn’t lock in the loss. Unless a stock has a dividend, I think buying it is pure speculation (rather than less-frivolous investing (which is just ostensibly-cautious speculation)). Non-dividend stock should be bought with venture capital (mentality). From that standpoint (heavy growth or bust), I think FB is cheap. Why? Well, that’s for next time. Bye bye!