Parents vs. kids Most people approaching middle age from well-to-do families or with professional careers are looking forward to a time when they can make themselves independently wealthy: having enough money, in your control, to create passive income sufficient to meet your needs.

In working with various families through our relationships with businesses of all sizes, we have come to recognize that there's a different model that many wealthy parents pursue: they want to make their children "dependently wealthy." By holding the purse strings, failing to nurture, mentor, or teach skills, and by allowing themselves to intrude on significant life decisions (marriage, home ownership, career development), these parents maintain control over their childrens' lives just as if they were still teenagers. We know of families that have this relationship with grown children who themselves have children!

Dependently wealthy -- it really doesn't help your children grow up, especially when they're 35.

Monday, February 25, 2008 :: posted by Rick Colosimo @ 11:34 AM

Math doesn't lie The linked article from the New York Times purports to reveal how hedge fund managers are profiting from inside information (the term of art is "material nonpublic information"). In this case, the secrets refer to pending PIPES (private investment in public equities). If, as the article suggests, a pending PIPES deal is likely to cause a stock to drop, then a trader with advance knowledge should be able to take advantage of that information.

Here's the money quote:

To be sure, not every PIPE causes a company’s stock to drop. Measured Markets, a Toronto research firm that looks for anomalies in stock trading, examined PIPE’s valued from $100 million to $250 million that companies on the Nasdaq or the American Stock Exchange issued in the first half of this year. Only half — 9 of 18 — had their shares drop in the 30 days leading up to the deals. (One of the company’s stocks stayed flat and the other eight rose.) Of those that fell, the average decline was 8.6 percent. Of those that rose, the average increase was 20 percent.

So, if we're right and math doesn't lie, what's the value of this strategy? I bet $100 on each deal. I win $8.60 nine times, break even once, and lose $20 eight times? That's a return of about $1800 + $77.40 - $160 = STUPID. Who needs to prosecute people for using inside information if this is actually what happens to them? The market is punishing enough.

Well, the NYT might say that these inside traders can reduce their exposure with options and margin and other things, but the fundamental nature of those numbers is that making all short bets is a loser, pure and simple. Unless this hypothetical trader can figure out which deals are going up and down, which was the point of the exercise, you have to be exposed the same on all of them. Maybe an investor will decide to hedge the downside, but that hedge has to cost money too, and so without specific evidence that it was possible at the time, we're sticking with the simple math.

What's the right question? Why does the NYT consider this story as proving anything, in spite of the plain calculations they present? All it does is highlight the question of why people don't know this: most inside information isn't. Rumors are already public knowledge by the time they get to you. Unless you start the rumor, it's almost certainly not worth trading on (and then, of course, it is more plainly illegal market manipulation). The rationale that we find likely is that it makes hedge funds sound even worse to say that they are making money on the misfortune of others, since many people aren't bothered by hedge funds making money when stocks go up.

What's an even better question? Why not investigate the people who are betting that PIPES stocks will rise, since they're making 20% returns on those bets! It makes us glad that we've become journalists looking for the story behind the story.

Labels: hedge, inside information

Sunday, February 24, 2008 :: posted by Rick Colosimo @ 4:58 PM

MSFT-YHOO: what does it mean? The linked article from the NY Times argues that Microsoft's offer to buy Yahoo signals Microsoft's failure in growing a profitable, competitive online business organically. This might be true to the extent that Google is unmistakably the biggest dog in the fight, but it's not the whole story.

A significant problem for companies as large as Microsoft is simply how to engineer sufficient growth to be meaningful. After all, creating a new $1b business from scratch, a fantastic achievement in the business world, would give Microsoft a seemingly paltry 2% growth on $51B of 2007 revenue. Certainly Berkshire Hathaway was not upbraided for noting in its 2006 Annual Report [PDF, 962kb] that large gains "will come only if [they] are able to make large, and sensible, acquisitions."

The law of large numbers encourages, almost requires, market participants the size of Microsoft (market cap $265B) and Berkshire (market cap $213B) to acquire large companies to meet growth expectations from Wall Street.

Google (market cap $162B) has made a few large acquisitions, but they have not been primarily focused on acquiring revenue or profits; rather, many of Google's deals have focused on buying the equivalent of billboard space: opportunities for it to present more ads both directly and indirectly.

Saturday, February 09, 2008 :: posted by TSC Managing Director @ 12:59 PM

Microsoft - Yahoo: working against the deal A number of stories since the Microsoft bid have discussed what Yahoo might do to avoid Microsoft's offer. Too few stories have explored what Yahoo actually has to do: the board's fiduciary duties require it to maximize shareholder value. Anything less than that opens them up to suit for breach; the business judgment rule will protect them a long ways, but there are limits.

Our position has always been that the company belongs to the shareholders, who pay the directors and officers to handle things on a short-term and day-to-day basis. The long-term basis is covered by shareholders directly by voting for the board, responding to offers to sell their shares, and by voting on other significant decisions.

The linked article laments how Yahoo is "light" on anti-takeover provisions. But that completely misses the point. Shareholders don't have to sell -- that's all the takeover protection any company needs, and officers and directors who push for classified boards, poison pills, golden parachutes, and change of control provisions run the risk of conflicts of interest when these mechanisms serve to perpetuate the control over the firm that these fiduciaries exercise. (As an aside, we are reminded of a financial advisor that established a dynasty trust for an ultra-high net worth family and conveniently selected the advisor's affiliate company to serve as the trustee in a jurisdiction less favored than Delaware, to be sure.)

Between the market cap of a company like Yahoo, the sheer size of the float, and restrictions on ownership accumulation matched with disclosure obligations, there are plenty of obstacles to eliminate the opportunities for an acquirer to "steal" a company without a chance for shareholders or the board to push for a high-enough price to include a control premium.

There have also been many reports, starting with what some might consider an ill-advised blog post by Google's general counsel, referencing possible antitrust concerns raised by the prospective merger. Of course, when one considers Google's dominant market share in search-based advertising, even when compared to a merged Microsoft-Yahoo, Google seems less concerned about preserving competition than preserving its advantage.

:: posted by TSC Managing Director @ 12:53 AM

Microsoft puts Yahoo in play The big news on Friday was Microsoft's bear hug letter to Yahoo's board. The news was announced before market open on Friday, and the >60% premium in Microsoft's offer was quickly arbitraged away, leaving a much smaller spread (<10%) Wired today notes that the cultures might not be as far apart as everyone thinks. What will be key in this culture match, we predict, will be the drive to combat Google's dominance in search advertising and related fields.

Perhaps Microsoft saw this article about the lopsided market valuation of Yahoo in relation to its various operating businesses and minority interests. This sort of arbitrage, calculating the break-up value of companies, doesn't necessarily lead to the idea that a company will or should be broken up. For Yahoo, the key point might be that its minority interests are separate enough from the core business that they can be sold off for cash with little or no change to the value of the core. Similarly, looking at those minority interests and smaller segments is important for a strategic buyer such as Microsoft because that's where opportunities for synergies come from. Sure, "reducing back office costs" is a common-enough source of cost savings, but companies with significant goals need to look for ways to improve the top line as well. In another context, we've told more than one small-business client: "you can't cost-cut your way to growth."

We will try to put together a post on the merger-arbitrage opportunity for Microsoft-Yahoo to further illustrate that aspect of the hedge fund business. The challenge for us will be to eliminate discussions of our proprietary modeling factors while still providing value for our readers. But we'll try. Finally, the interesting way to analyze this deal will be the effect on Google. Clearly, Google is subject to surprisingly large swings in its price, 5 or 6% at a time. That is a huge volume of money given the market cap. If Microsoft and Yahoo sign a deal, what does that mean for Google? One could argue that Google is already competing against these two companies and so there is no real change; neither Microsoft nor Yahoo seems to have a viable strategy lacking only the resources to execute it; they are far, far behind in market share. What does a merger really open up in terms of competitive power? That is the $6,400,000,000 question (about 4% of Google's market cap).

Labels: merger arbitrage, synergies

Monday, February 04, 2008 :: posted by TSC Managing Director @ 1:47 PM