This morning, telecom giant AT&T announced it will spin off and merge its media unit with content provider Discovery Communications.  Telephone will control 71% of the new entity, which will sport a projected $76 billion market cap and $132 billion enterprise value.   

That transaction closes the book on a less-than-blissful corporate marriage, as AT&T coughed up $85 billion for TimeWarner just three years ago. The move nevertheless earned plaudits from a key constituency, as Ma Bell unwinds a growth-by-acquisition strategy under former CEO Randall Stephenson that pushed net debt to $205 billion (inclusive of operating lease and pension liabilities) as of March 31, earning the dubious distinction of the world’s most encumbered non-financial company.  Shareholder Elliott Investment Management deemed the deal “another impressive step in the company's recent evolution.”  

Mr. Market also liked what he saw initially, as shares jumped 4% at the market open to briefly log a fresh 52-week high.  Yet that rally soon faltered (T stock closed lower by nearly 3%), perhaps reflecting another byproduct of the transaction: A forthcoming dividend cut.  AT&T announced today that, following the spin-off, it will allocate between 40% to 43% of free cash flow, now projected at roughly $20 billion this year, for shareholder payouts.  That compares to a projected $26 billion in full-year free cash flow and a dividend payout ratio in the “high 50%s range” as of the first quarter earnings release. 

Income investor pain is the creditors’ gain. This afternoon, Moody’s affirmed its Baa2 senior unsecured debt rating on AT&T with a stable outlook. Though the company remains “weakly positioned for the Baa2 rating,” Moody’s believes that proceeds from that dividend cut will serve to both pay down debt and smooth AT&T’s maturity schedule to eliminate principal repayments in excess of projected free cash flow.  The spinoff will bring the Moody’s-calculated leverage toward 3.6 turns of Ebitda from the current 3.8 times.  

That decision has arguably been a long time coming, as generous shareholder payouts in tandem with an aggressive capital structure (the average Baa rated borrower carried just 2.7 turns of leverage as of last fall) can, of course, make for a dicey combination.  An updated bearish assessment of AT&T in the April 2 edition of Grant’s Interest Rate Observer concluded that, “as a large and frequent borrower, AT&T needs its Baa2 rating. We judge that it needs the rating even more than it needs the gratitude of income-seeking investors.” 

Yet a slimmed-down corporate portfolio doesn’t necessarily spell the end of AT&T’s recent troubles. Analysts at MoffettNathanson argue that this morning’s outcome was an inevitable one, as its onerous debt load constrained the company’s ability to properly invest in the business, including expensive outlays for 5G wireless technology and the HBO Max streaming service rollout.  

While investor focus shifts back toward execution in the core wireless communications business, Ma Bell still faces a tough road ahead thanks to ferocious competition. Namely, rival T-Mobile can now boast both better pricing and a superior network thanks to its recent purchase of spectrum-rich Sprint Corp. last year, while Verizon launched its own 5G salvo by spending $45 billion in a c-band spectrum auction earlier this year, double AT&T’s investment.  MoffettNathanson gets the last word:  

Indeed, the big question for AT&T will be, is even this – including their dividend cut – enough? AT&T will get back $43 billion in cash and/or assumed debt, and 71% of the equity in the new company. 

Time Warner’s Ebitda supported a little over $43 billion of debt at AT&T, so AT&T is still over-levered after the transaction (about 4.0 times EBITDA including pension and capital lease obligations). With their dividend cut, their payout ratio will drop only modestly and their capital expenditures will increase. But all will still depend on whether they can grow their mobility business. We have our doubts.

Stocks edged lower to start the week, with the S&P 500 and Nasdaq 100 each declining by about 30 basis points, while Treasurys also came under modest pressure as the 10- and 30-year yields rose to 1.65% and 2.36%, respectively.  WTI crude jumped above $66 a barrel for its best finish since October 2018, while gold rallied to $1,845 an ounce to extend its six-week gains to 11%.  Bitcoin slumped below $45,000 from $50,000 on Friday evening, and the VIX rose to near 20. 

- Philip Grant

A thunderbolt from the social media heavens.  Yesterday evening, Elon Musk announced on Twitter that Tesla would no longer accept bitcoin as payment. The catalyst for that reversal from a mere three months ago: “Concern about rapidly increasing use of fossil fuels for bitcoin mining and transactions, especially coal, which has the worst emissions of any fuel.”  That de-endorsement helped drive down the price of bitcoin to as low as $48,000 overnight from $55,000 yesterday afternoon. 

While Musk’s pivot grabbed the headlines, a potentially far more significant crypto development took place hours later.  This morning, controversial stablecoin tether released its composition of reserves for the first time.  Tether, the most traded crypto by volume, had long claimed to be fully backed by U.S. dollars before gradually relaxing that language in early 2019. Yet the outfit disclosed that, as of March 31, traditional reserve assets such as cash and Treasury bills summed to a mere 3% and 2% of total reserves, respectively.  In lieu of currency and liquid government debt, more esoteric securities filled out the bill: Commercial paper accounted for roughly half of reserves, with fiduciary deposits, secured loans, corporate bonds and precious metals representing about 18%, 13% and 10% of that total. 

That snapshot generates more questions than answers. As CoinDesk notes, “It is unclear what the ratings are on the commercial paper or the corporate bonds, which agencies rated them or which companies issued them. Likewise, Tether declined to identify the borrowers of the loans or the collateral backing them.”

Another eye-catcher: “Reverse repo notes” accounted for 3% of reserves. In a traditional repurchase agreement, a borrower sells an asset with an agreement to buy it back later at a higher price. In reverse repo, a lender buys an asset from a borrower who promises to repurchase it at a later date. Repo and reverse repo are agreements between two counterparties and not publicly traded securities. It is unclear what, if anything, the notes in “reverse repo notes” signifies. 

Indeed, that line item is a curious one, as tether has used obscure, Bahamas-based Deltec Bank & Trust as its primary lender since 2018. As tether is known as a workaround for know-your-customer and anti-money laundering regulations that govern the regulated banking system, today’s disclosure invites the question of who would serve as a counterparty for such a transaction and, if an intermediary helped facilitate that deal, what sort of fees tether would be obliged to pay that third party.  Might the assets underpinning those reverse repo deals be cryptos?

In any event, this morning’s disclosure is unlikely to mollify skeptics either on Wall Street or in the halls of government.  Recall that, in February, New York attorney general Letitia James concluded in a settlement (which levied an $18.5 million fine and barred the company from doing business in the state) that tether’s “claims that its virtual currency was fully backed by U.S. dollars at all times was a lie,” (Almost Daily Grant’s, February 23). That admonishment has done little to slow the breakneck growth in tethers outstanding.  Instead, the quantity in circulation has gone parabolic in recent months:  

 
Source: Coinmarketcap.com

More broadly, the Financial Times notes today that government entities across the West are stepping up their scrutiny of stablecoins, as concerns over difficulty in tracing transactions, consumer protections and inconsistent disclosure practices proliferate.  “Certainly, the direction of travel is to look at regulating them,” concludes John Salmon, head of law firm Hogan Lovells’ cryptocurrency practice. 

A crackdown on the digital Wild West is perhaps already underway.  Both the Justice Department and Internal Revenue Service are conducting investigations into Caymans-incorporated Binance Holdings, the world’s largest crypto exchange by trading volume, Bloomberg reports this afternoon.  “Officials who probe money laundering and tax offenses have sought information from individuals with insight into Binance’s business,” Bloomberg explains. 

A little heat from Uncle Sam doesn’t seem to bother the Binance c-suite.  Founder and CEO Changpeng Zhao downplayed the significance of that report, and tweeted this morning: “You know what to do in a dip, right?”

Stocks managed a modest bounce, with the S&P 500 gaining 1.2% to narrow its loss for the week so far to 2.8%, while the Nasdaq rose by 70 basis points to trim its four-day decline to 4.5%.  Treasurys caught a bid despite a weak 30-year auction this afternoon, with the 10-year yield declining to 1.66%.  Gold edged higher to $1,827 an ounce, WTI crude sank below $64 a barrel and the VIX pulled back by 16% to 23 after reaching a two-month high yesterday. 

- Philip Grant

Perennial Super Bowl champion quarterback Tom Brady took the digital plunge this morning, adding laser-eyes to his Twitter profile. That flourish connotes devotion to cryptocurrencies.

  
Today’s social media wardrobe change comes a month after Brady announced the launch of Autograph, a non-fungible token company selling digital memorabilia. 

Fallout from Friday’s disappointing jobs report continues, as Federal Reserve officials ruminate on the implications for monetary policy.  The net addition of 266,000 jobs, far below the consensus 1 million, seemingly ensures that emergency policy pillars of a near-zero federal funds rate, in tandem with $120 billion in monthly asset purchases, will remain firmly ensconced.  

While the 6.1% headline unemployment rate is near its long-term average of 5.8% going back to 1947, comparisons with the strong jobs picture at the tail end of the record-length 2009 to 2020 economic expansion make for sub-average optics.  Noting that U.S. payroll figures remain some 8 million below their pre-pandemic levels, Minneapolis Fed president Neel Kashkari declared Friday that “we are still in a deep hole and we still need to do everything we can to put those folks back on to work more quickly.”   “I think we’re going to have to see more strong employment numbers and we’ll have to see [rising] inflation” prior to any stimulus pullback, Chicago Fed president Charles Evans added this morning.   

That mentality is catching on beyond America’s borders.  In an interview with the Financial Times today, European Central Bank governing council member Olli Rehn argues that the ECB should follow the Fed’s lead in welcoming above-trend inflation: “From the point of view of economic and social welfare it makes sense to accept a certain period of [inflation] overshooting, while taking into account the history of undershooting.”  

A secular decline in the natural rate of interest, or the academically-conjured theoretical interest rate which maximizes employment and output without spurring inflation, underpins that perspective. “A focus on full or maximum employment makes sense in the current context of a lower natural rate of interest” Rehn reasons.  Notably, the ECB is charged solely with maintaining price stability, as opposed to the Federal Reserve, which operates under the dual mandate of full employment and stable prices.  

Then, too, Uncle Sam’s growing coordination of ultra-loose fiscal and monetary policy is similarly in vogue overseas.  Tomorrow, Australia’s federal treasurer Josh Frydenberg is reportedly set to deliver a “jobs budget” featuring increased infrastructure spending, along with additional new outlays and tax cuts designed to spur consumption and hiring. “There’s certainly been a shift in the fiscal stance to a singular focus on getting unemployment as low as possible and that’s very consistent with what the Reserve Bank of Australia is doing,” Su-Lin Ong, head of Australian economic and fixed income strategy at the Royal Bank of Canada, tells Bloomberg. 

Of course, long dormant price levels have played a central role in policymakers’ ever-more dovish progression. Yet red-hot home, used vehicle and commodity prices, along with a nine-year high in inflation expectations as measured by the 10-year breakeven rate (i.e. the difference in yield between inflation protected and fixed-rate Treasurys), highlight the risk of regime change. 

The powers that be admit to no doubts. Kashkari assured his audience Friday that, were inflation to reappear on the scene, the Fed “has the tools to make sure we do not have a repeat of the 1970s.”  While such a confident reading of the Fed’s control of events is par for the course, the 2002 essay “Monetary-Policy Rules and the Great Inflation,” from Athanasios Orphanides, professor at the MIT School of Management and former ECB governing council member, reaches a conclusion that could give pause to the monetary mandarins: 

Retrospectively, policy choices during the 1970s may appear unsystematic, myopic and even inconsistent with basic principles of what macroeconomic models sometimes suggest is good policy practice.

[However], policy was consistent with an inflation target of 2%, which should have safeguarded the goal of reasonable price stability. Policy responded strongly to forecasts of inflation and the unemployment gap, which could have been reasonably expected to result in a high degree of economic stability. Policy was meant to guide the economy to its ‘optimum feasible path,’ consistent with what some ‘modern’ research emphasizing activist policy design would suggest would be the ‘optimal’ strategy to follow. Yet economic outcomes were disastrous.

The central bankers’ key mistake, Orphanides continued: “The pervasive ignorance associated with attempts to quantify the notions of ‘natural’ rates of interest and unemployment in real time.” 

See the Jan. 21 edition of Grant’s for an instructive analysis of the devolution from the 1960s-era monetary Valhalla of low inflation, full employment and strong growth to the stagflationary morass of the following decade. 

Stocks came for sale with the S&P 500 declining 1.1% while the Nasdaq 100 shed a hefty 2.6%, leaving that-tech heavy gauge up just 3.5% so far this year compared to 11% for the broad S&P.  Treasury yields pushed slightly higher ahead of $126 billion in 3-, 10- and 30-year auction supply later this week, while WTI crude slipped back below $65 a barrel and gold rose to $1,838 an ounce.  The VIX jumped 18% to 19.6, its most elevated close since late March. 

- Philip Grant

Exit the stock jockeys. Domestic cash equity trading volume fell below 10 billion shares per day in April according to the CBOE and Jefferies, down 27% sequentially and roughly 18% year-over-year.  Eschewing plain old stocks, punters are migrating to the next big thing.  Citing data from CryptoCompare, the Financial Times relays today that trading volume in digital currencies reached a record $1.7 trillion last month, up from $1.2 trillion in March and $100 billion in April 2020.  

Share prices, as measured by the S&P 500, may remain at their all-time highs, but exponential gains from the likes of meme-crypto dogecoin seem to have captured the public zeitgeist.  “Dogecoin is surging because many cryptocurrency traders do not want to miss out on any buzz that stems from Elon Musk’s hosting of Saturday Night Live,” Edward Moya, senior market analyst at FX trading firm OANDA, observes to the FT. 

This morning, S&P downgraded International Business Machines to single-A-minus from single-A.  The ratings agency cited IBM’s ongoing corporate shopping spree, including some $1 billion of deals in the first quarter and the announced acquisition of application software firm Turbonomic last month for a reported $1.5 billion to $2 billion, a strategy that casts doubt on IBM’s ability to cut its net leverage to less than two turns of Ebitda over the next 12 to 24 months.  S&P had pegged the company as triple-A as recently as 1993, and double-A-minus as recently as 2017. 

There has been some balance sheet progress despite those acquisitions, as IBM has trimmed its debt burden by $6.9 billion over the last six months. Yet net borrowings remain at $50 billion, equivalent to 2.7 times consensus 2022 adjusted Ebitda.  For context, the average single-A-rated borrower carried an even 2.0 times net leverage, with 2.7 turns representative of the average triple-B-rated corporation, according to data published by Moody’s last fall. 

IBM bulls enjoyed a bit of good news in the form of first quarter earnings announced two weeks ago, as the $1.77 of adjusted earnings per share topped the $1.65 per share consensus estimate.  The company managed to eke out 1% sales growth from its year-ago level, its best year-over-year showing for the top line since the second quarter of 2018. 

Supercentenarian IBM (founded in 1911) likewise raised its quarterly dividend by a penny to $1.64 a share, marking the 21st consecutive year of increasing dividends and its 109th year of remitting quarterly payouts.  Shares have rebounded to their best levels since February 2020. 

Great expectations play no part in the snapback. The Street currently pencils in $10.93 in adjusted earnings per share for calendar 2021.  In the spring of 2018, those analysts had expected adjusted earnings on the order of $17 per share this year.   

Nor does strong capital allocation figure in the bullish story line. Charlie Bilello, founder and CEO of Compound Capital Advisors, noted on Twitter back in January that IBM has shelled out a whopping $165 billion for share buybacks over the previous 25 years, far in excess of its current $134 billion market cap. Similarly, a series of acquisitions, including the $34 billion purchase of Red Hat in 2019, have done little to move the needle.  Consensus 2022 revenue of $75.3 billion, net income of $10.8 billion and free cash flow of $12.1 billion trail 2016 revenues, net income and free cash flow of $79.9 billion, $13.1 billion and $13.5 billion, respectively, when net debt stood at $26 billion, or roughly half of today’s levels. 

IBM bears, of which Grant’s has long counted itself, often highlight the C-suite’s proclivity for financial engineering to paper over chronically slow growth, as revenue has compounded at a meager 1.1% annual rate since 1985, less than half of the 2.5% compound annual growth in CPI over that multi-generation period.  An analysis from the long-ago March 30, 2001 issue summarized the state of play at Big Blue: 

Students of the art of zaitech [the financial engineering made famous during the 1980s-era Japanese stock bubble] will be speechless in their admiration of the virtuosity of IBM. The rest of us should stand clear.

A late ramp higher for the S&P 500 left the broad index up 80 basis points to reach a new high-water mark, while the tech-heavy Nasdaq 100 lagged for a fourth consecutive session with a 40 basis point advance. Treasurys went nowhere as the 10- and 30-year yields remained at 1.57% and 2.24%, respectively.  Gold jumped nearly 2% to $1,815 an ounce, its best finish since late February, WTI crude slipped below $65 a barrel, and the VIX retreated to 18.4. 

- Philip Grant

Baby and beauty products retailer the Honest Co. took another step towards a public market listing yesterday. The company declared in a filing that it will offer 25.8 million shares at between $14 to $17 each, with a projected $1.54 billion valuation at the top end of that range.  Honest, which posted a $14 million net income loss on $300 million in revenue last year and is co-founded by actress Jessica Alba, will list on the Nasdaq exchange in the coming days under the ticker HNST.

It’s been a long time coming for the nine-year old firm, as former CEO Brian Lee told The Wall Street Journal that Honest was “starting to think and act like a public company” way back in 2014.  A year later, the company raised $100 million in a series D private funding at a $1.7 billion valuation. Yet, stalling sales growth (the top line first reached $300 million in 2016) and product recalls, including one for allegedly ineffective sunscreen, helped derail that momentum. Honest subsequently lost its unicorn status, as a September 2017 series E funding round bestowed a valuation of just under $1 billion. 

Now, with Mr. Market smiling down and the finish line in sight, insiders look for the exits. Per the filing, existing shareholders will offer 19.36 million shares in the upcoming IPO, accounting for a bit more than three-quarters of the total offering size. 

The world makes, Uncle Sam takes. The U.S. government ran a $74.4 billion trade deficit in March, data from the Commerce Department released today show. That follows the $70.5 billion trade shortfall logged in February and marks the biggest monthly gap since at least 1992.  In other news, the federal budget deficit reached $660 billion last month as spending reached $927 billion, up a cool 161% year-over-year and the third highest reading on record after June and April of last year. 

Surging bond issuance is part and parcel with those massive figures. The U.S. Treasury announced yesterday that it plans to borrow $463 billion from the public the second quarter, far above the prior $95 billion estimate issued in February, as stimulus-related borrowing needs have crystallized.  That figure will grow to $821 billion in the third quarter if yesterday’s estimates are on the beam.  Similarly, Treasury issued $401 billion in marketable debt during the bygone first quarter, up from a $274 billion projection less than three months ago.  

That imminent deluge comes as debt held by the public now stands at $22 trillion, up 29% from mid-March 2020, as the government ramped up spending in response to the pandemic. Then, too, the monetary mandarins have duly done their part to help facilitate the debt binge. With $5.01 trillion in Treasury securities holdings as of last week, the Federal Reserve’s portfolio now accounts for 22.7% of public debt outstanding, up from 13% when the bug bit in March of last year.  

Those striking figures, in tandem with an economy projected to post its best year in terms of output growth since 1984, are causing some concern even among the monetary uber-doves who occupy the halls of power. “It may be that interest rates will have to rise somewhat to make sure the economy doesn’t overheat,” Treasury secretary and former Fed chair Janet Yellen warned on a podcast released today.  “It’s not something that I’m predicting or recommending,” Yellen hastened to add during a subsequent online event this afternoon. 

Of course, traditional economic orthodoxy would suggest that ballooning government debt in tandem with vigorous economic growth would represent ideal conditions for rising inflation, yet long-dormant price levels, to say nothing of chronically declining interest rates, have left such hypotheses out in the cold. John Cochrane, chaired senior fellow at the Hoover Institution at Stanford University, authored a 2011 essay “Inflation and Debt,” a theory of public credit that Grant’s termed last month to be “logical, contrary and historically grounded, even if, in the last 10 years, it has enhanced no bond trader’s P&L.”   

Past is prologue. Might the current backdrop, featuring unchecked fiscal profligacy and de facto debt monetization, finally spur inflationary regime change?  See the April 2 edition of Grant’s for Cochrane’s updated assessment of this essential topic. 

Stocks came under pressure, with the S&P 500 dropping 70 basis points and the Nasdaq 100 shedding 190 basis points for its worst showing since mid-March, while Treasurys caught a modest bid with the 10- and 30-year yields dwindling to 1.59% and 2.26%, respectively. Gold pulled back to $1,779 an ounce, WTI crude jumped to near $66 a barrel, and the VIX reached a five-week high at 19.5. 

- Philip Grant

“The staffing shortage is real,” Mark Fox, president and founder of Fox Lifestyle Hospitality Group, tells Bloomberg. 

Fox, whose firm owns four restaurants in Manhattan and which postponed the reopening of the White Oak Tavern in Greenwich Village for want of qualified employees, explained his predicament. “I don’t want to lose revenue, but I will not lose reputation of the restaurant by trying to open it with undertrained or underpowered staff levels.”

An earnings season for the record books takes shape.   With roughly half of S&P 500 component companies reporting results as of yesterday, nearly 90% of that group topped consensus analyst estimates, which would be the best showing since Bloomberg began tracking such data in 1993.  

Boomtime conditions for corporate America could spur the stock market to even greater heights, some believe.  This morning, Credit Suisse strategist Jonathan Golub raised his full-year earnings forecast to $200 per share for the S&P 500 from a previous $185 a share projection, and now pencils in a Street-high 4,600 year-end price target for the broad index, up from a prior guesstimate of 4,300. “In the early stages of an economic cycle, analysts tend to underestimate operating leverage, leading to positive revisions, a trend that can last 2-3 years,” Golub writes. 

Dominant showings from the big tech cohort are, of course, part and parcel with the current euphoria.  The Apple, Amazon, Facebook, Google and Microsoft quintet combined for a whopping $322 billion in revenue during the first quarter, up 41% from a year ago and on pace to eclipse the IMF’s full-year GDP forecast for Mexico.  Earnings for the group footed to a combined $75 billion, up 105% year-over-year and equivalent to Egypt’s projected 2021 output at the current pace. 

But while eye-popping performance from the FAAMG cohort steals the financial headlines, the “old economy” is likewise percolating. Thus, railroad traffic has rebounded by 9.4% so far this year compared to the pandemic-wracked 2020, according to the Association of American Railroads.  Mr. Market likes what he sees, as the Dow Jones Transportation Average today put the finishing touches on its 13th consecutive weekly advance.  That approaches the gauge’s record-long weekly winning streak of 15, set back in 1899, The Wall Street Journal notes today.  The Dow Transports are up a heady 23% year-to-date, lapping the 11% and 8% gains for the S&P 500 and Nasdaq 100, respectively.  

Indeed, the broad-based advance has made it difficult to find laggards.  Bloomberg relays that more than 95% of the S&P 500 has closed above its 200 day moving average on each of the 18 trading sessions month-to-date through yesterday.  Previously, that broad average had only seen 95% of its components finish above their respective 200-day moving averages on 17 total occasions going back to the beginning of Bloomberg’s data series in 1990. 

Some draw cautious lessons from the anomalous trend. Matt Maley, chief strategist for Miller Tabak + Co. wrote Monday that the 200-day average distribution metric “is much like [investor] sentiment. When it is strong, it is positive, but when it becomes extreme, it becomes a contrarian indicator.” 

The bull crowd had better hope that other outliers do not represent contrary indicators of their own. Gregory Blaha of Bianco Research relayed yesterday that the U.S. stock market aggregate capitalization reached 205.8% of nominal GDP as of March 31, easily topping the 183% in March 2000 to mark the most elevated reading of the past century.  Similarly, the combined value of domestic stocks and bonds reached 318.5% of nominal output at the end of March, blowing past the 240.6% high-water mark established at the peak of the tech bubble. 

More blistering data, in the form of a 38-year high for the April Chicago Purchase Managers’ Index, didn’t help stocks, as the S&P 500 declined by nearly 1% to erase its gains for the week, while the VIX rose to 18.5, its highest weekly finish since the end of March.  Treasurys went nowhere, leaving the 10- and 30-year yields at 1.62% and 2.29%, respectively, while gold held at $1,767 an ounce and WTI crude retreated from yesterday’s six-week highs, settling at $63.50 a barrel. 

- Philip Grant

Trade-in values for used vehicles hit a record $17,080 in March, analysts from Edmunds compute.  That’s up a cool 20.8% from a year ago.   Strong demand, in tandem with sharply diminished inventory (off 36% from a year ago) thanks to a shortage of computer chips, have “combined [to disrupt] the market in a way we haven't ever really seen before," commented Jessica Caldwell, Edmunds' executive director of insights.  

That supply crunch looks to get worse before it gets better. Bloomberg noted yesterday that all five of the major global automotive chipmakers have seen inventory growth dwindle in their most recent reporting period.

This just in, from Reuters:

The U.S. securities regulator is considering new guidance to rein in growth projections made by listed blank-check companies, and clarify when they qualify for certain legal protections, according to three people with knowledge of the discussions.

Food delivery giant DoorDash, Inc. (DASH on the NYSE) announced today that it will roll out a tiered fee structure, offering participating restaurants commission schedules ranging from 15% to 30%. Those choosing the lower, “basic” end of the spectrum will see a reduced delivery radius, deemphasized digital real estate on the DoorDash app and extra fees passed on to the end customer.  Conversely, restaurants opting for the top-level “premier” plan receive the widest range, along with prominent placement on the app and additional marketing support.  DASH COO Christopher Payne predicted that most restaurants will opt for the 30% tier, describing the premier plan to the Financial Times as the best way to maintain the “status quo.” 

Local government-mandated fee caps figure prominently in that pricing shift.  By Dec. 31, some 73 separate jurisdictions, including New York, Chicago and Los Angeles, had enacted legislation limiting the commissions that DoorDash can charge restaurants, which had typically peaked at the same 30% figure featured in today’s press release.  Those curbs cost the outfit an estimated $36 million in Ebitda during the fourth quarter, a figure which management projected in February will “almost double” in the first quarter (DASH is set to report those results on May 13).  

In an April 7 blog post lamenting the fee caps, DoorDash revealed that, after the company tacked on an additional $1 to $2 worth of per-order levies to end customers in locales like St. Louis, Philadelphia and Westchester County, N.Y. in response those commission ceilings, volume sank by as much as 7% in March from a year ago. “We’ve seen a tangible impact of the basic economics rule: when prices go up, demand goes down,” the blog concluded.  Price elasticity in action. Of course, customers are only too happy to consume subsidized products. 

By contrast, DASH shares currently resemble a type of Giffen good. Following a 5% rally today, the company sports a $53 billion market cap, up from $32 billion at its Dec. 8 IPO price and $16 billion from a series H funding round conducted 10 months ago.   The sell side expects DoorDash to finally reach the black this year, with a projected $101 million in net income.  That compares to a $1.3 billion aggregate loss in the three years through 2020.  

With increased regulation and a return to normal life posing a threat to revenue growth, the cost side of the equation looms large in DoorDash’s efforts to meet Wall Street’s great expectations. Yet the gig economy mainstay, which, like its peers, classifies workers as independent contractors rather than employees to avoid paying out health insurance and other benefits, must contend with bourgeoning worker dissatisfaction over the arrangement.  

The April 6 edition of Bloomberg Businessweek shone a spotlight on the #DeclineNow online forum, a 40,000 member social media group of “Dashers” who have banded together to reject delivery orders below a certain threshold, in hopes of pressuring the dispatcher to up the ante.  The #DeclineNow leadership sees the gig arrangement in zero-sum terms. “Every app-based, on-demand company’s objective is to constantly shift profits from the driver back to the company,” contractor Dave Levy told BusinessWeek. “Our objective is the reverse of that.” 

While gig economy firms have a clear incentive to work together in beating back labor reform, other areas of cooperation are less clear.  Last Thursday DoorDash settled a lawsuit with Olo, Inc. after accusing the restaurant delivery software firm of “fraudulent concealment” and “cheat[ing] its largest business partner.”  Olo, according to court documents, promised DoorDash that it would never charge fees higher than it asked of any other delivery provider. Instead, upon completing a takeover of rival Caviar in 2019, DoorDash discovered that its target had enjoyed a “significantly lower” payment schedule. 

That’s why you have to get the premier plan. 

Treasurys came for sale in bear-steepening fashion, as the 10- and 30-year yields climbed to 1.62% and 2.29%, respectively, while stocks finished flat for a second straight day after ascending to new highs Friday. WTI crude jumped above $63 a barrel, gold edged lower to $1,775 an ounce, and the VIX remained at 17.5. 

- Philip Grant

Private equity continues to circle Toshiba Corp. (6502 on the Tokyo Stock Exchange), after the Japanese conglomerate rejected a ¥2.28 trillion ($20.7 billion) bid from CVC Capital Partners.   Reuters relayed yesterday that Bain Capital is also looking to bid on Toshiba and has engaged a pair of local banks to secure financing for a potential approach.  Rivals KKR and Brookfield Asset Management are also interested, per the report. 

That deal derby follows a March vote in which activist shareholders successfully forced an independent probe into whether management improperly influenced investors ahead of a vote on director nominations at last year’s annual meeting. 

The rare boardroom victory, marking only the fourth time an activist shareholder proposal has passed in Japan and the first for a major company, could reverberate. “There have been false dawns before,” Justin Tang, head of Asian research at United First Partners, told Bloomberg on April 8. “But activism is taking hold now.”  Indeed, some 44 activist funds operated in the country last year according to data from IR Japan Holdings, double that of three years prior. 

A confluence of other factors suggest that the stars are perhaps aligning in the Land of the Rising Sun, where the TOPIX Index sports a 9.6 times enterprise value-to-2021 consensus Ebitda ratio, compared to 10.6 times for the Europe’s Stoxx 600 and 15.5 times for the S&P 500.  A paper this month from the Man Institute concluded that “a combination of a less crowded market, cyclical resurgence, valuation stretch, and market inefficiency has made Japan the most attractive equity market in the world for active managers focused on value.” 

Authors Jeremy Reifer and Jeffrey Atherton argue that, apart from favorable positioning dynamics (foreign ownership of Japanese equities reached an eight-year low last fall) and the pro-cyclical and value-heavy weighting of the domestic indices, structural factors could serve to support share prices.  Thus, government regulations enacted in 2016 have directed listed companies to target an 8% return on equity, while encouraging shareholders to vote out the boards of those enterprises which fail to achieve that bogey over three consecutive years.  As a result of that diktat, Japanese firms that manage an RoE of 8% or higher enjoy an outsized valuation premium on a price-to-book-basis compared to the laggards, as opposed to other countries where the relationship between RoE and valuation is a linear one. 

Japan’s regulator-driven bifurcation can yield some compelling opportunities, Reifer and Atherton believe: 

For a stock picker, this represents something close to nirvana – a huge, highly predictable market anomaly without high levels of foreign inflows which would compete it away. Most importantly, the likelihood of a cyclical uplift means that a number of stocks with high levels of operational leverage are likely to be able to raise their RoE above 8%, presenting opportunities for active managers. 

The irony is that achieving the hallowed 8% is not even that hard. Management teams have a number of levers to improve RoE – such as negotiations with suppliers, share buybacks and reducing unnecessary expenditure such as travel costs – but have traditionally shrunk from pulling them.

Attention Japan bulls both nascent and longstanding:  See the Jan. 22 edition of Grant’s for more on the investment backdrop in the world’s third-largest economy, along with picks-to-click. 

Stocks enjoyed a strong rip, with the S&P 500 advancing by more than 1% to erase yesterday’s late selloff and settle near unchanged for the week, while Treasurys came under modest pressure with the 10- and 30-year yields each rising a couple basis points to 1.56% and 2.24%, respectively.  Gold ticked lower to wrap up its second straight week at a patriotic $1,776 an ounce, WTI crude jumped back above $62 a barrel, and the VIX fell 7% to finish near 17. 

- Philip Grant

A flood in a coal mine in China’s Xinjiang region shut down 35% of bitcoin’s global mining power over the weekend, Fortune reported yesterday. The loss helped drive the cost of transferring or making a payment in bitcoin to $52 from $16, relays Alex de Vries, founder of Digiconomist, and may have contributed to the pre-eminent crypto’s 14% pullback from last Friday.

It may come as a surprise to some hodlers that a power disruption of one of the smallest of Xinjiang’s 61 counties could have such a big impact on the famously decentralized blockchain.  “We now know for sure that one-third of all production runs on pure coal from a tiny place in China,” de Vries told Fortune.  The crypto specialist estimates that fossil fuels generate some 70% of global bitcoin mining, with coal power accounting for the bulk of that figure. 

De Vries projects that, if the price of bitcoin were to hold near $60,000 over the next few years, annual electricity output from mining could reach 284 terawatt hours.  For context, at the current 102 terawatt hours, bitcoin mining accounts for roughly 2%, 10% and 31% of total U.S., Russian and U.K. electricity output, respectively. 

The high concentration of bitcoin mining in the Middle Kingdom itself raises other concerns, as anyone who controls 50% or more of bitcoin’s computing power can reorder bitcoin transactions and spend the same coins multiple times in a so-called 51% attack. Might China, which accounts for around 65% of bitcoin hashrate (i.e. the computer power required to mine and process crypto transactions), call domestic miners to their patriotic duty in a future conflict with the West?

Epitome of the cycle redux.  Bloomberg reports today that SoftBank Group Corp. is seeking to upsize a recent $8.125 billion margin loan backed by shares in Alibaba, Inc. to $10 billion.  The deal is likely to be priced at a 250 basis point premium to Libor. 

While the tech conglomerate has made tangible progress on its asset sale-cum-share repurchase strategy shift announced last year and has ridden the bull market wave to a cool 272% rally from its March 2020 lows, today’s news may leave some observers cold.  Moody’s Investors Service noted March 8 that, although SoftBank has undertaken an estimated ¥5.6 trillion ($51.5 billion) in asset sales, topping its ¥4.5 trillion target announced last year, the company’s cash balance remained little changed at roughly ¥2 trillion.  Instead of bulking up its “dry powder,” SoftBank reinvested those proceeds into listed U.S. tech companies through subsidiary SB Northstar LP.  Moody’s laid out its thinking: 

[We] will consider downgrading the ratings if the credit quality and transparency of SoftBank’s investee companies deteriorate, including a further decline in the company’s ownership of (1) its dividend-paying SoftBank Corp. subsidiary, without a commensurate increase in stable dividends from other sources; or (2) Alibaba, without an increase in other liquid assets.

This is not the first time that SoftBank founder and CEO Masayoshi Son has used favorable conditions to double down.  On Feb. 19, 2020 (the day the S&P 500 logged its pre-virus highs), SoftBank announced it would take out a ¥500 billion margin loan backed by shares of its holdings in domestic telecom operator SoftBank Corp.  Moody’s deemed the loan credit-negative two days later on account of additional leverage and complexity in SoftBank’s capital structure, as well the potential for weaker recovery for senior bondholders were the company to default.  A month after that, the rating agency cut SoftBank to Ba3 from Ba1.  

Meanwhile, the state of play at Alibaba, the collateral for Masa’s latest margin loan, remains an open question.  BABA shares are 28% off their October highs, as co-founder and former executive chairman Jack Ma has all but vanished from public view after drawing the Chinese Communist Party’s ire with critical remarks in a speech last fall. 

Stocks snapped out of their recent lethargy, with the S&P 500 erasing early losses and finishing at the highs of the day with a near 1% advance, while Treasurys held steady to leave the 10-year yield at 1.56%.  Gold rose to a near two-month high just below $1,800 an ounce, WTI sank to $61 a barrel, and the VIX pulled back to 17.5, retracing about half of its gains over the fist two days of the week. 

- Philip Grant

According to data from Goldman Sachs, median short interest as a percentage of float across the S&P 500 has fallen to 1.6%, near the lowest reading since 2004.  Outsized pain precipitated the short sellers’ retreat, as a basket of highly shorted stocks compiled by Goldman has ripped higher by some 30%, compared to the 11% advance for the broad index so far this year. 

 “There’s just mass euphoria,” Benn Dunn, president of Alpha Theory Advisors, tells Bloomberg. “No one wants to get their head ripped off by a short anymore.”

While the bears head for the hills, the bulls double down.  Data from FINRA released today (thank you, Kevin Duffy) show that margin debt among member firms reached a record $822.5 billion in March. That’s up 35% from the average for March across 2018 and 2019 and 82% above last year’s virus-influenced figure. 

The picture is brightening for embattled asset manager China Huarong Asset Management Co., following a hair-raising few weeks after the state-owned company failed to report results by a March 31 deadline.   On Friday, the China Banking and Insurance Regulatory Commission declared that Huarong is operating normally with “ample” liquidity and is working with auditors to release its 2020 annual report as soon as possible. In response, the company’s Baa1/single-A-rated 3 3/8% dollar-pay notes due in May 2022 rebounded to near 89 cents from a 65 cents nadir on Wednesday, per Bloomberg. 

Protracted problems at the firm would surely resonate. Huarong, which was ironically one of a quartet of concerns formed to help clean up nonperforming loans after a late-1990’s credit crack-up, is majority owned by the Chinese government while also counting A-list Wall Street names like Goldman Sachs, Warburg Pincus and BlackRock among its largest equity investors.  A 2018 accounting scandal, culminating in the execution of former chairman Lai Xiaomin for bribery earlier this year, colors the recent turmoil, as does the fact that Huarong and its subsidiaries have issued more than $22 billion in offshore bonds according to Refinitiv.  Nearly $4 billion of those borrowings fall due later this year. 

Analysts from CreditSights write today that a withdrawal of state support for Huarong’s obligations “would, at a minimum, lead to higher spreads for the obligations of Chinese state-owned entities and, for some, remove access to the dollar bond markets altogether.”  The Chinese government apparently reached a similar conclusion, as Peking University finance professor Michael Pettis noted on Twitter yesterday:

Once again, they took it to the brink and then backed away. By late Thursday it seemed, at least among the people I speak to, that the regulators recognized that a major credit event around Huarong would be financially more destabilizing than they were prepared to accept.

A Huarong failure could accelerate signs of creeping instability, as corporate defaults across both local and offshore debt have footed to $16.7 billion year-to-date through last week. That compares to $29.4 billion in full-year 2020, itself up 14% from the year earlier.  Then, too, the base of assets (and liabilities) continues to swell: Non-financial corporate debt stood at 163% of GDP as of Sept. 30, up from 150% year-over-year, while China’s total banking assets reached $49 trillion at year-end, or nearly 60% of global GDP last year. 

The recent scare may have spurred the powers that be to pursue conflicting policies. Reuters reported Friday that regulators have instructed state-affiliated banks “to be prepared to support Huarong.”  That comes less than a month after the People’s Bank of China reportedly told financial institutions to reduce lending activity following a 16% year-over-year increase in bank lending through February.

More broadly, the Huarong saga, which follows the defaults of state-affiliated Baosheng Bank in 2019 and Yaosheng Coal last fall, underscores the limitations of the state’s implicit financial backing of highly leveraged enterprises. Logan Wright, director of China markets research at Rhodium Group and speaker at the 2018 Grant’s fall conference, comments in an interview today that:

What the Huarong situation, and similar credit events beforehand, signify is that the market just can't be sure about how Beijing or local governments are going to make these choices. 

As we like to say, there's now a question of ‘Are local governments really a source of stability reinforcing these guarantees or are they a source of risk in the market based on how they might allocate assets—either protecting investors or potentially exposing them to defaults?’

For more on Huarong and China’s efforts to contain a Frankenstein-like banking system, see the most recent issue of Grant’s dated April 12.  

A rare down day for stocks saw the S&P 500 and Nasdaq 100 indices decline by 50 and 100 basis points, respectively, while the VIX jumped more than 6% to snap a streak of seven consecutive closes below 17.  Treasurys also came under pressure, with the 10- and 30-year yields rising to 1.61% and 2.3%, respectively, while WTI crude climbed to $63.5 a barrel and gold pulled back to $1,771 an ounce. 

- Philip Grant