The Mock P. O. Craze

I want to trade mark the term "Mock PO".  It's just what you think: a fake IPO.  Remember, you read it here first.  LinkedIn and Pandora come to mind.  Sell a tiny sliver of a company to the public at an absurd price. The $64,000 Question: Why?

I've written before that private equity and venture capital firms ex ante expropriate their clients assets.  What about ex post?  Can investors suffer another round of pain?  Management fees transfer substantial value from investor to manager, but real manager value depends on expected performance fees.  If markets turn south, how do you make performance fees?  How do you cover the burn rate on the yacht?  An MPO may be the answer.

How does it work? 

Very limited public float (i.e. don't really sell much more than a sliver of the company) holds the price artificially high because of incredible demand for new companies in hot sectors.  (I'm not convinced of this argument, but the world seems to be buying it...the market seems to forget all the shares that could be sold...)  In simple terms, imagine you could sell 5% of the company at a $20 billion valuation, or 50% at $10 billion.   

Fund documents typically allow managers to distribute positions in-kind.  Again typically, investors perceive this as a last ditch move by managers for still private companies that cannot be sold, but nothing precludes distribution of public stock.  Finally, nothing precludes taking performance fees on in-kind distributions.  (To say nothing of catching up on losses or hurdle rates!)


So, the VC fund takes potentially very large performance fees on valuations that their investors can never realize because when the investors sell the stock, the "exclusivity premium" baked into the stock price falls to zero.  In the end, the investors hold the $10 billion valuation company...after the VC fund takes their performance fee on the $20 billion one.

Time will tell if the strategy works.  I certainly hope I'm wrong.

Jimmy Stewart Cared, But Why Should You?

I have a confession: I've made it this far in my life without ever seeing It's a Wonderful Life.  I consider this an accomplishment for someone who studied economics.  You cannot imagine how many lecturers reference a single scene of an old film.  All I know is that Jimmy Stewart has the teller window slammed on him at the bank.  He apparently didn't like that.

Most people reading this wouldn't particularly care if their bank failed.  Your deposits fall below FDIC insurance limits, so you won't lose anything.  I know several people who have experienced failure in their primary banking relationships, and they barely noticed.  Most bank failures since FDIC, luckily, have not hurt any depositors.

Bank failures more likely strike blows at companies. Imagine some very large deposits. Microsoft's cash to make payroll on January 31st, for example.  At some point, it must sit in a reasonably small number of places.  Not in $250,000 slices.  Microsoft has no interest in taking risk with their payroll, for even an instant, when someone else, (shareholders of a bank) reap the rewards.  Or, maybe they do break it magically into $250,000 slices.  That has a cost.  Microsoft shouldn't have to bear that cost, or the risk.

Gold is overdone as a disaster hedge, and costly to carry

I first met John Burbank in probably late 2001 when Passport Capital was a very small enterprise. Incredibly bright, nice guy. I don't recall if "Passport" was then a reference to fleeing the country. My recollection is not. Today's WSJ piece on Passport's gold investing raises some interesting issues for gold as a hedge against all disasters.

Passport set out to take delivery of physical gold against futures to see if it was really as easy as it seemed. They did a 100 ounce test. Here are my thoughts.

They claim physical delivery is cheaper than ETFs.

• Custody problems.  Gold has to be verified as gold.  This is not free.  Once you take delivery of gold bars and have them in your possession, as far as the market is concerned they are no longer gold bars.  There's a cost to verifying that they remain gold bars.
• Storage costs.  Sure, Passport was willing to take a $90,000 flier.  They are very wealthy guys.  The situation would be substantially different if they took delivery of $90 million.  There would be security costs, transportation expense, and serious storage problems.  This is exactly the point of a prior WSJ story about the dearth of official gold storage facilities in and around New York City.
• Liquidity.  There's a lot to discuss here.  For the most part, custody and storage cover the trading costs of gold.  Why's that?  Sell financial futures short, and deliver physical against settlement.  However, delivering physical against settlement isn't so easy if you don't have official storage.

That's not to say I love the ETFs. There's a fundamental problem, I believe, when dealing with serious dollar disasters as a US investor. The Federal Government has outlawed private gold backed currency. I don't think it is much of a stretch to argue the ETFs that hold physical gold are a privately issued, gold backed currency. Each share is a claim on physical gold held in trust. It's really there, that's the appeal. It isn't a purely financial instrument. So, except for costs of physical delivery (much like the old days of going to the Fed to demand gold) the certificate for the ETF is "as good as gold." That means when the real disaster strikes, you're out of luck. The US government has good grounds to seize your property.

I know this sounds far-fetched. But, if you are really thinking about holding gold for the end of the world scenario, you need to understand the risks.

Now, one last problem, that a friend of mine always raises: What do you do with the gold? Do you really think you slice off a couple of grams of your 100 oz gold par to buy some cans of tuna fish??