The Saturday - 11/07/2020 Edition
Volume 1, Issue 7
Good morning!
Did you know that American Idol is coming back for a 19th season? I still remember when the show came out in 2002; that and Who Wants To Be A Millionaire? were staples in our house.
Looking back, those were the golden days of competition shows. Entertainment, suspense, and……… votes tallied in real time! How 2002 is that?
It’s Saturday November 7, 2020.
Mea Culpa
I owe you an apology. In last week’s edition, I stepped up to the keyboard and did my best Babe Ruth impression, pointing to the heavens and calling my shot:
Next week, there will be a new record holder for largest IPO of all-time when Ant Group’s stock begins trading publicly on the Shanghai and Hong Kong exchanges.
Unlike the Bambino, I whiffed. With Ant’s offering massively oversubscribed, a record-breaking issuance seemed like a sure thing. What I failed to account for, however, was the risk that after months of planning and marketing the offering, Chinese regulators would pull the plug on the IPO just days before the stock was to begin trading.
On Monday, the China Securities Regulatory Commission summoned Ant founder Jack Ma to its office for a conversation. What was discussed is unclear, but by Tuesday evening, Thursday’s IPO had been called off. IPOs being pulled this late in the game - by regulators, no less - is near unprecedented. Sure, WeWork’s IPO flamed out, but that was due to lack of demand and the company cancelled the offering itself.
Naturally, theories abound as to what transpired. The CSRC claims that the delay is due to concerns about the adequacy of the company’s disclosure of risk factors. Others speculate that Ma’s criticism of China’s financial system in late October - more specifically, his assertion that “there’s no financial system in China” - opened the company to retaliation from the Communist Party.
What we do know is that a week after Ma’s comments, the CSRC announced new rules taking aim at “tech” companies operating in the periphery of finance and requiring that consumer loan providers - such as Ant - fund 30% of loans using their own capital. According to Bloomberg, Ant currently funds just 2% of its loans itself. While the company is presently valued higher than JP Morgan Chase, analysts believe that the new rules could stunt its growth and cut its valuation in half.
Did Xi Jinping want to put Ma in his place? Did China suddenly realize that “tech” companies should be regulated the same as legacy companies? Is Ant a financial institution? Is Twitter a publisher? So many questions.
The big question now is when will Ant be allowed to go forward with its IPO? Rumors range from two to twenty-four months. In the meantime, investors who had pre-ordered shares were returned their money.
Well, most of it. Those who took out 20x leverage will still have interest expense to cover. Bankers!
Sweet Relief
This summer, a large donor and former chairman of the University of Colorado’s investment committee made headlines for filing suit against the school’s foundation. The $2B fund’s transgression? Underperforming the S&P 500.
According to the plaintiff, the S&P 500 outperformed the University of Colorado Foundation by approximately 5.49% annually form 2010 to 2019. If true - the school disputes the allegation - that should certainly be cause for concern for donors.
That being said, courtrooms are an odd venue to extol the virtues of passive investing and the suit’s potential repercussions could fundamentally upend an entire industry. Investment managers getting sued for underperforming benchmarks? Courts are already backlogged!
Well, advisers and managers need not worry. Last week, cooler minds prevailed and the suit was dismissed with prejudice. I think that’s a good outcome; everyone and their mother has an opinion about passive investing - even The Saturday - but the last thing we need is attorneys opining on investment strategies.
Payments Stuff
The Chinese government wasn’t the only one meddling in corporate transactions this week. In the U.S., regulators have been relatively active this year, prosecuting antitrust cases against poultry companies and Google. Their new target? Visa and Plaid.
On Thursday, the DOJ filed suit against both companies, seeking to block Visa’s $5B acquisition of the fintech unicorn. While Plaid might not have the same brand recognition as Uber or Square, it is nonetheless one of the most potentially disruptive startups, making this latest turn quite newsworthy.
To help understand the crux of the DOJ’s position (which they explain fairly well in the complaint linked above), here’s an oversimplified overview of the online payments industry:
When a customer purchases goods online using a debit card, the merchant notifies its bank, who in turn uses debit networks (such as Visa’s or Mastercard’s) to communicate with the customer’s bank and obtain authorization for the transaction. In addition to connecting the banks, debit networks also guarantee the transaction.
Today, Visa controls 70% of the massive online debit transactions market, while its nearest competitor (Mastercard) has only 25% market share and has struggled to increase penetration. Because of the high barriers of entry - a classic chicken & egg problem, where the networks need customers to attract merchants and need merchants to attract customers - Visa’s debit payments business generates billions of dollars yearly at 88% operating margins.
Enter Plaid, whose platform connects apps such as Venmo and Betterment to customers’ bank accounts through a process called “screen scraping.”
Let’s say you use Venmo, the PayPal-owned app that allows users to send money to friends from their phone. Venmo has a built-in Plaid integration through which you, when installing the app, can choose your bank and enter your login credentials. Plaid takes those credentials, logs into your bank account for you, copies the account information, and relays it to Venmo. Now, Venmo (who does not get your bank login credentials) can process payments via ACH, which is a form of bank-to-bank transfer.
Bank-to-bank transfers are cheaper than debit network fees, so lowering barriers to that transaction structure could be bad for Visa’s business. To quantify the difference, merchants must pay Visa $0.39 in fees to process a $60 transaction through its debit network, whereas bank-to-bank ACH fees for the same transaction would be $0.02.
Plaid currently only processes data, not payments, but the DOJ contends that the company had pre-acquisition plans to expand into payment processing and that “by acquiring Plaid, Visa would eliminate a nascent competitive threat that would likely result in substantial savings and more innovative online debit services for merchants and consumers.”
With 11,000 financial institutions and 200 million consumer accounts on its platform, Plaid is indeed uniquely positioned to eventually challenge Visa. Per the regulators, Visa is acutely aware of these risks. The complaint quotes a senior Visa executive expressing fear that the giant would become the IBM to Plaid’s Microsoft and comparing the upstart company to “an island volcano whose current capabilities are just the tip showing above the water.” Apparently, the exec even drew the volcano!
That’s the DOJ’s side of the story, at least. According to Visa, the complaint is “legally flawed” and “reflects a lack of understanding of Plaid’s business and the highly competitive payments landscape in which Visa operates.” Furthermore, while Plaid could eventually cut into Visa’s online debit business, it still has a long way to go before it replaces the payment icon: Visa reported over $23B in 2019 revenues, while Plaid barely exceeded $100M.
I’m not sure how this one plays out. Visa’s market dominance and huge margins are a good incentive to stifle Plaid’s growth or at least hedge against a powerful newcomer. On the flip-side, financial institutions need to leverage technology to remain competitive and (crucially) to offer better services to their customers. Requiring legacy players to build out their tech solutions internally makes them less competitive internationally and results in slower development and poorer products available to consumers.
Monopolies are bad and government-mandated obsolescence is also bad, but I’m an optimist. I think this ends well. I just don’t know how yet.
Reality Check
Popular thinking suggests that electoral uncertainty is bad for markets. It’s also been said that gold and bitcoin are good, uncorrelated hedges to equities. Anyways, some highlights from the week:
Next President: (arguably) TBD
Senate Majority: TBD
Nasdaq: up 8%+
S&P 500: up 6%+
Gold: up 3%+
Bitcoin: up 15%+
Heck of a week. I won’t keep you any longer.
Have a great weekend!