Levine on Wall Street: Ephemeral Valuations

Matt Levine is a Bloomberg View columnist writing about Wall Street and the financial world.
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Snapchat is worth $10 billion.

This observation is not original to me, but when Kleiner Perkins Caufield & Byers agrees to invest $20 million in Snapchat at a $10 billion valuation -- so ... 0.2 percent of the company? -- then that's a little bit like when Cynk gets a $6 billion valuationfrom a couple of million dollars' worth of trades. I mean, Snapchat is a real company and stuff, but it is probably not worth $10 billion. Rather, it is probably a binary where either it's the next [insert name of internet company that doesn't make me sound as old as if I'd said "the next Facebook"] and Kleiner Perkins will look like geniuses, or it'll fizzle ("Snapchat has yet to unveil a business model") and Kleiner Perkins will be out $20 million, which it can afford. Or I don't know maybe it'll sell to Facebook or whoever for $15 billion and Kleiner Perkins will make a modest return, but that does feel like the least likely outcome. You can average across those outcomes and come up with $10 billion or whatever, but it seems unlikely that that is the math that Kleiner Perkins is doing, so this data point does not really support that number except in the most mechanical sense. And probably not even in that sense, given liquidation preferences and so forth.

Get ready for bigger ticks.

The Securities and Exchange Commission's tick size pilot program is moving along, with the SEC releasing the plan for public comment yesterday. Some small-to-mid-cap stocks will trade in 5-cent increments, others will quote there, and others will have a "trade-at" rule in addition to the 5-cent thing. The idea, as we discussed a while back, is roughly that paying market makers more to provide liquidity might make for higher-quality liquidity. You can be skeptical about that if you want, but the nice thing is that the SEC is operating by controlled experiment rather than a priori guesswork: They'll run the pilot program, see how it works, and then decide what to do. Maybe everyone will interpret the evidence of the experiment the same way, and agree on the right answer! I mean, probably not, but you can hope.

Elsewhere in market structure.

This Citi story -- fined $1.85 million for not giving customers the national best bid or offer price on 14,800 preferred stock trades because it priced those stocks manually on presumably a fixed-income desk -- probably doesn't mean anything beyond that preferred stocks are a weird corner of the world. Everyone thinks of them as fixed-income, and is surprised that they're supposed to be traded like stocks. It's not, like, a Markets Are Rigged Story. On the other hand I cannot disagree with this guy:

“The findings are disturbing,” said Mark Williams, a former Federal Reserve bank examiner who now teaches risk management at Boston University. “You would expect a sophisticated shop like Citi to get the pricing correct. It means there continues to be a weak control environment at Citi, which is concerning.”

Like, yes, it's weird that preferred stocks are subject to NBBO rules, but come on! You're a bank! You're supposed to know that. Meanwhile Merrill Lynch was fined $1.2 million for overcharging customers for clearing fees. From past experience this seems like the sort of thing where I write "this is way too boring for me to contemplate" and then someone e-mails me to tell me (correctly) that it's actually fascinating and shady so, you know, have at it.

Allergan will hold its shareholder meeting.

So that's a win for Pershing Square and Valeant: Allergan will hold a special meeting on December 18 to vote on, loosely speaking, the proposed merger with Valeant. (Really on replacing the board with the intention of etc. etc., but you get the idea.) The downside is that Allergan is trying to block Pershing Square from voting its shares because it still thinks those shares were obtained by insider trading. So we have an exciting, wow, four months ahead of us.

Don't insider trade.

The "director of market intelligence at a Manhattan-based investor relations firm" was charged with insider trading because he allegedly looked at clients' draft press releases and then "routinely purchased stock or call options in advance of favorable news and sold short or bought put options ahead of unfavorable news." Here is some market intelligence for you: Don't insider trade in short-dated out-of-the-money call options! Come on. Irresistibly, DealBook says"Now, his gains have become a publicity nightmare," though I feel like the public relations component is the least of his worries.

Evil magicians and Aladdin.

I point you to this Black Bag post about the BlackRock Aladdin risk management system not to endorse it, exactly, though I do want to endorse the line about "the culture of leniency [New York Attorney General Eric] Schneiderman's office has cultivated around punning and other word crimes," that's right on. But Aladdin is a big interesting thing -- here is Tracy Alloway last month -- and I sort of can't resist mentioning it. One error here, which I think is a common one, is conflating risk management software with quantitative investing software. Aladdin answers -- for BlackRock and the many other firms that license it -- the question "if Event X happens, what will happen to the value of my portfolio?" And it does that with statistical methods that might worry you from a Black Swan and/or groupthink perspective. (I mean, might worry you abstractly; I have no idea what those methods are. But any method of numerically estimating investing risks will probably enrage Nassim Taleb, and any method used to manage trillions of dollars had better be very very robust.) But it doesn't answer the question, "what should I invest in?" For that, you need a view on whether or not Event X will happen, or if Event Y will happen instead.

The R in Brevan Howard was pretty good.

The main thing I took away from this article is that Brevan Howard is an acronym, which I shamefully did not know. ("Brevan Howard was co-founded in 2002 by five 'fixed-income traders from Credit Suisse': Alan Howard, James Vernon, Jean-Philippe Blochet, Chris Rokos, and Trifon Natsis. The company name was created by utilizing portions of the last names of the co-founders.") Howard got his whole name in, since he was the boss, but Rokos -- the R -- did okay too: He "regularly contributed over a fifth of the total trading profits of Brevan Howard's main 'Master Fund' between 2004 to 2012" despite being, if you're counting carefully, only one sixth of the acronym. Anyway now he's suing to get out of his non-compete and is disclosing the fund's dirty secrets in court.

What is a corporation?

I got into a conversation a while back about whether people still believe that shareholders "own" corporations, which strikes me as a non-rigorous and sort of passé view of the world. If you think that, or if you don't, I recommend Martin Wolf on corporate governance and the purpose of the corporation. Reasonable people may disagree on some of the orientation here -- I might be more sympathetic to shareholders oppressed by managers than he is, for instance -- but overall it is excellent. More importantly, it is the right model for how to think about corporations and stock: Corporations are separate entities bound to shareholders not by simple "ownership" but by "implicit -- or not fully specified -- contracts" that exist in part to remove the corporation from the pure control of the shareholders.

Things happen.

Being the head of the IMF seems like a risky job. Bob Diamond's African bank company is re-listing. Credit rating agencies will probably have to do more paperwork to pretend that they're not conflicted. Harvard Management Company's compensation is "increasing at a much faster rate than the endowment," complain alumni. Some raindrops fall too fast.

This column does not necessarily reflect the opinion of Bloomberg View's editorial board or Bloomberg LP, its owners and investors.

To contact the author on this story:
Matthew S Levine at mlevine51@bloomberg.net

To contact the editor on this story:
Toby Harshaw at tharshaw@bloomberg.net