I like this quote from Ron Conway mentioned in @nichcarlson’s article about Facebook becoming cash flow positive, and IPO-able:
“The next big thing is Twitter-like “persistent data,” which is “real-time data as its happening.” It’ll be a multi-billion economy.”
He predicts a huge market opening up over the next few years around recent data.
Apple buying Twitter is not such the uninteresting proposition it’s been called, for instance by Dan Frommer’s piece yesterday Why Apple Won’t Buy Twitter. With $29b in cash, they have a pile of cash which could be deployed over several strategic acquisitions to morph themselves to into a tech giant that could become the dominant tech/media competitor to Google.
What’s the prize for Apple? For one, a revaluation to Google PEs and possibly higher. This would build on the current decent PE of 23, then adding a new layer of high growth potential with now internet search advertising and media to Apple’s existing businesses. Apple as a tech media business, with iTunes, iPhone, and Twitter/Twitter search as a triple platform is a winning plan. I’d venture to guess that if advertising were in place on Twitter Search now, the eCPMs would kill AdWords at the moment. Google primarily earns click revenues from it’s first page of search, which suggests the “deepness” provided by Google’s search results is not required for ad revenues, it’s only the first couple of pages that matter.
In an Apple acquisition, Twitter should remain a separate brand and act as a separate division of Apple. The expansion of Apple’s business is where the value lies for Apple, rather than in the incorporation of Twitter into iPhone, MobileMe, etc. I agree with Dan Frommer, that makes no sense.
Here’s a high level look at each company:
Google is arguably still in the best position to monetize Twitter immediately, as it fits into their existing business. However, the Google brand might eclipse the Twitter brand, which would minimize the overall value in the long term because the “now internet” growth could very well be inhibited or forgotten when Twitter is gobbled into the intestines of the Google acquisition engine.
I’ve been commenting on other people’s blogs for long enough on this subject, so I’m going to try to formulate my thoughts more concisely with some blogs about it. Twitter and Facebook have long been dubbed the social internet, but their true value is really that they are the pioneers of the now internet.
I think the internet business is about to go through a vast reorientation around the “now” - piggybacking on twittering, facebooking and blogging. What’s going on now, meaning this second, is soon going to be the first thing that someone will ask when going to a website. Publishing and dissemination of this information, what goes out and to whom, is at the center of this change. We want the right information to go to the right people, and that can get complicated.
Twitter, FB, and blog updates have paved the way, but they don’t have the resources or infrastructure to provide the full breadth of this functionality to companies, groups and organizations. A company has employees, officers, managers, customers, clients, board members as well as campaigns, promotions, projects, events and initiatives. A company also has the media and financial markets to consider in its communications: reporters, analysts, investors, potential investors, and traders. There are official company announcements, which might be internal or external, and there are communications created by individual people. Individual people’s communications can be as relevant as official company pronouncements.
All of this “now” information is not encompassed by any company, not Twitter, not Google. Much more infrastructure is needed to achieve effective publishing and sorting of this data into what will be the now internet.
I have been pulling for a Google acquisition of Twitter, although at the same time am beginning to see far greater opportunities with the IPO-ing of now internet companies. This brings fresh blood and renewed investment interest from the war-torn small investor.
Fred Wilson’s blog post today predicts end of the IPO drought is coming. Realistically, Twitter has nowhere near the revenue to do a classic IPO, but they have far more depth of market penetration into the psyche of the general population than most IPOs. (I remember when my mom bought CNS stock in the late 80s when she saw football players wearing BreatheRight strips)
Raising capital with a public valuation sooner rather than later may provide far greater bang for the buck in terms of building infrastructure and staff to meet the needs of the market where its best opportunity exists. If Google is the internet’s juggernaut of today (the distribution outlet, the lens, the tool, the screen, whatever metaphor one wants to use), Twitter has the potential to hold that same place as the juggernaut of tomorrow, the cornerstone of the now internet.
Currently, Twitter provides both the “pipe” and the “search lens” for the now internet - which at the expansion levels seen, is overwhelming to one company of 40 or so people. One thing to consider is that Google provides only the “search lens” for the data, and wouldn’t conceive of trying to be the “pipe” at the same time; that infrastructure is layered into what comprises the vast majority of internet companies.
Facebook and Twitter IPOs open doors to a slew of new business opportunities for laying the foundation of what will be the backbone of the now internet. IPO-able companies/software in this space are Twitter and Facebook, and perhaps for external communications and 37Signals on the internal corporate communications side.
On their own, these companies cannot effectively cover the needs of the now internet market. Hopefully we will be seeing launches of companies that will be agencies, software providers, SaaS and infrastructure companies to grow the market out of it’s “social networking” roots and into the far bigger “now internet” space. It will be interesting to watch companies that are providing financing to this space like Union Square Ventures and early stage groups like Social Leverage.
If you thought the AIG or Merrill investment banking bonuses were too high, you might not be feeling the love for the finance industry’s top hedge fund managers either. They got paid a wee bit more.
There’s #1 James Simons of Rennaisance Technologies at $2.5 billion, but things fall dramatically off after that. Consider #4 George Soros at $1.1 billion.
These reported earnings surely come with tax. Executive compensation at hedge funds is taxable, but rather thinly so, at the capital gains rate, 15%. The Obama budget seeks to tax these incomes as income, fancy that.
One might also ask what value is created by hedge funds in their heroic role of taking trading positions? Maybe some, arguably, as they are going to be perhaps the buyers of many a “toxic asset”. The rise in value of those hidden gems once they are off bank balance sheets could certainly help Paulson, Simons and Soros regain their $3+ billion paychecks from 2007.
Sometimes problems are bigger than we thought. Sometimes we need a bigger boat.
Here’s a reblog of an article by DKMatai which calculates the face values of “all derivatives”. I think this article is sensational and incorrect to use this sort of math to estimate the size of the financial crisis.
http://www.siliconvalleywatcher.com/mt/archives/2008/10/the_size_of_der.php
There are risks to many derivatives, leveraged ones and credit default swaps, certainly, but lets take for example interest rate swaps.
Example: Interest Rate Swap
Putting on the Trade - Most swaps trades are put on at zero value (they exchange a fixed bond rate for a floating rate), either between a bank and a company or a bank and a bank. In this case, we’ll say its between a large corporation, GN, and a large bank, called PIG. The face value of our example swap is on GN’s bond issuance of $1 billion. The market value of the swap on day 1 is simply the net present value differential of leg 1 of the swap vs leg 2, which is zero to start.
Change in Rates - Let’s say there’s a change in rates, so the value of our $1b GN-PIG swap might change by 12-15% if there were a 100 basis point shift in rates. This has no impact on GN’s balance sheet other than the small changes in semiannual floating rates its making its swap payments on. (The swap changed GN’s fixed rate bond to a floating rate bond). There’s no change to PIG’s balance sheet or income because it has hedged both the fixed and the floating rate legs of the swap in the bond market.
Somebody Defaults - Let’s say PIG defaults on this swap, then GN would simply go back to paying its fixed rate on its bond. If GN defaults on its bond and the swap, and if the swap is underwater (otherwise, GN would just unwind the swap and take its profit), then PIG will simply unwind it’s hedge and would lose the NPV of difference between its cash flow expectation on the swap vs. the hedge, which amounts to a spread of the interest rate changes that were hedged by PIG. So in this case, there’s a derivative, the swap, but there’s really no leverage, nor is there the possibility for an enormous meltdown. The $1billion value of the swap is simply a face value; no one can lose $1b here.
Change in Credit Risk with No Default - But wait, there is another type of risk where PIG can lose money. The mark-to-market value of the swap can also change if either counterparty has a change in their credit rating. So, theoretically, PIG is holding an interest-only “note” in receiving the fixed rate payments from GN and next GN’s credit rating is downgraded, then the mark-to-market value of the whole swap goes down (by the NPV of GN’s new fixed theoretical borrowing rate). While GN may be in no danger whatsoever of not making payments on the $1b bond or the swap, PIG has to reflect the change in the price of this swap immediately on its balance sheet.
Credit Risk and Capital - Any bank’s, including PIG’s, normal business practice would be to allocate very little of its risk capital to such a swap, as it is capable of hedging most of the risk, ideally 100% of its interest rate risk. As for its credit risk, that was likely hedged with a credit derivative. So low risk would indicate that PIG assign only a small amount of capital to hedge the different risks. And so the picture of how this meltdown happened begins to emerge more clearly. If hedge funds and banks are either at risk because of a paradigm shift in credit quality across every single security in the market, or default of a financial institution (Lehman, hedge fund) with which the credit risk was hedged.
Summary - Under a shift in credit spread scenario, if there were the same shift in GN’s fixed borrowing spread when its rating is lowered, 100 basis points, PIG must take that whole hit immediately on through its income statement (mark-to-market accounting), as if PIG was selling the security in the market. So PIG takes the entire hit of the lower price, even though the bond and swap are still in place, and absolutely no one has defaulted on any portion of this transaction.
Even if nobody defaults, everyone goes under
So it’s the combination of mark-to-market accounting rules and leverage that’s wiping out the theoretical values of retained capital on balance sheets of banks, rendering them insolvent. A shift to a just slightly more favorable economic environment (where credit ratings weren’t in free fall, but stabilized again, leaving many companies perfectly healthy) could make the whole financial crisis evaporate into thin air — as many assets that are underwater today could mark better with a fundamental shift in credit. That said, bankruptcies, shrinking GDP, small business failures, defaults, tight/unavailable credit, falling prices, falling asset values — the domino effect that’s in place has a much bigger chance of falling the other way, depression, massive unemployment and slow growth.
It’s not really the derivatives
So, blaming “derivatives” really misses the boat. The meltdown’s roots are much more steeped in the sub-prime mortgage crisis, low interest rates, easy credit, the real estate bubble, and leverage previous allowed to home buyers. By that kind of leverage I mean issuing a mortgage to a homeowner with no money down and accreting principal. The sub-prime crisis created a domino effect with healthy banks becoming insolvent essentially overnight due to the mark-to-market values of any mortgage-related assets they were holding, and any defaults from insolvent institutions.
It’s interesting to discuss capital here. When there’s no capital down, corporations and people can walk away. Our system has a built-in problem which kicks in during economic distress periods. If someone’s home goes to 50% of its purchase value, the homeowner is probably going want to walk away, particularly if they have a small amount of capital in the property. In this case, originally the bank was holding a mortgage, an asset, and when the owner walks away, they are now holding a house which at best is worth 50% of it’s value and needs to be maintained. Much of America’s housing is at about 50% of it’s peak level. Many intelligent homeowners would walk away on those economics alone, not to mention a layoff or a retirement fund wipeout.
Stephen Schwartzman of Blackstone Group sums things up pretty nicely for where this meltdown might go when it stops melting down.
http://www.reuters.com/article/wtUSInvestingNews/idUSTRE52966Z20090310
As of now, 45% of worlds wealth evaporated in the past 1.5 years. He mentions that the way out is private equity starting to buy into these assets.
Basically, it looks as if Barack will back this scenario, via Tim Geithner. If so, what could happen is a repeat of what his own rhetoric is condemning.
The US stock market was flat from 1961 to 1983. What pulled things out of the gutter? Basically, the rise of corporate raiders, m&a, Michael Milken, junk bonds, shareholder advocacy, undervalued assets (particularly real estate, hmmm). The lift and profits from private finance fueled stock values. Wealthy investors financed the wave of phenomenal growth that occurred from a rising S&P500 — silicon valley, software, dotcom. Those same private investors earned orders of magnitude more than any stock market investor in the same time frame again. Hedge funds know this. Stephen Schwartzman knows this. It might be helpful to understand what makes him tick, see this Steve Schwarzman NYMag profile from 2007.
Stockholders are basically the last ones to get paid; it’s a residual security. It’s really a derivative security, which no one seems to want to mention — derivatives not that much different from ones that carve up pools of mortgages with senior and residual tranches backed by a future cash flow. In a finance textbook, it would say that the theoretical value of a stock would be the npv of future cash flow expectations. Cash flow goes to bondholders and preferred stock holders before a cent goes to equity. Private equity and the US government are coming in at a seniority level above common stock. With leverage.
My point is that professional investors can take their money in and out often, again and again. They’ve taken the wind out of the sails of your retirement schooner. I know of one hedge fund employee that took every penny of their personal money out of the stock market in the early fall of 2007. We must look closely at the flexibility and privilege of the private finance institutions such as Blackstone who will step in to re-finance US companies. If the Obama administration favors this approach, the same scenario is going to be created again — fewer jobs from cost cutting, management getting a bunch of stock options for firing employees, quarterly ROI focus.
So if/when that 45% of wealth comes back, it will likely be even more distributed toward the wealthy. A lot more has to be reexamined to put the US economy on better footing than relying on the old guard. Real jobs, more jobs, a strong stock market, real growth. In the meantime, the public should get a better deal, there is really no need to make the rich richer when things bounce back, is there?
Henry Blodget speculates on Huffington that the S&P 500 could go as low as 300 (it’s at 700 now). Theory based on bottom-out PE ratios after bubbles; these can go to 5x, and we’re at 12x.
Henry suspects that as the bubble we had was the biggest ever 40xPE, the correction will end up being the lowest. A little bit of voodoo economics, yes, maybe. One has to ask, still, if interest rates went negative in Japan 10 years ago, why not stock prices in the US? People might have to be paid to hold on to paper that has a high likelihood of being worth less in the future.
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