Money Stuff: Bill Ackman Has Some More PSUS Ideas

The basic problem with the initial public offering of Bill Ackman’s proposed US closed-end fund, Pershing Square USA, was that he couldn’t give investors a discount. The fundraising pitch for PSUS was that you’d pay $50 for a share, and Ackman would invest that $50 (minus some underwriting fees) for you, in a portfolio of mostly large-cap US stocks but also some derivatives bets. It is entirely possible that $50 of Bill Ackman investments is worth more than $50; he has a good track record.

But it is also entirely possible that $50 of Bill Ackman investments is worth less than $50: Many closed-end funds, including Ackman’s own European fund, trade at a discount to net asset value. So when Ackman pitched his new fund to investors, they might reasonably have said: “Yes, sure, I would love to have you invest $50 for me. But I’d like to pay $45 for that. And judging by history, I’ll be able to pay $45 for a share a week after the IPO, so I’ll just wait and do that.” If everyone thinks that, then the IPO can’t get done: He needs to sell the shares at $50 before they can trade down to $45. And, crucially, he can’t sell the shares at $45: The point of the IPO is to raise the $50 to put in the pot, and selling the shares for less than $50 doesn’t accomplish that.

We talked about all of this a few weeks ago, when Ackman postponed the PSUS IPO, saying that the main question was “Would investors be better served waiting to invest in the aftermarket than in the IPO” and promising “to reevaluate PSUS’s structure to make the IPO investment decision a straightforward one.”

There are roughly three ways to think about how to restructure the IPO to effectively give the investors a discount to net asset value. The simplest way is: Put some cash in for them. The mechanism is something like:

1. You buy a share for $45.
2. Ackman puts in $5 of his own money, on your behalf, for free.
3. Your share represents $50 of the pot that he invests: $45 from you and $5 from him.

“You can probably spot the objections to this structure,” I wrote, but it’s actually not crazy. Ackman has a lot of money, so he could afford to do this. And in various ways a successful launch of PSUS would make him more money. (He will eventually charge fees on the PSUS assets, and he has plans to take the Pershing Square management company public; the more money PSUS manages, the better that IPO will go.) Just donating a billion dollars of his own money to the PSUS fund could be a positive-expected-value trade, for him.

You could play with that structure a bit more: Instead of putting in the $5 for free, Ackman could put in the $5 and get back long-term out-of-the-money warrants that pay him, like, $10 if PSUS does really well over the next two years. You pay $45 and get most of the returns on the $50, so you get a discount to net asset value, but you give him back some of the returns if he does really well.

Another way to restructure the IPO would be to put something else in the pot:

1. You buy a share for $50.
2. Ackman donates some asset to the pot.
3. Your share represents $50 of cash that he invests, plus your share of the asset that he donates.

The most obvious asset here is Pershing Square itself, that is, the hedge fund and closed-end-fund management company that Ackman runs. Pershing Square recently sold 10% of itself at a $10.5 billion valuation and plans to go public as soon as next year. Ackman could give investors in PSUS a stake in the management company as an incentive to buy PSUS.

This approach has some advantages over using cash. For one thing, it doesn’t require cash; Pershing Square can just issue shares of itself. It arguably aligns incentives nicely: By owning part of the management company, PSUS investors are effectively getting back some of the fees that they pay. Also, this creates some room for differences of opinion about the value of Pershing Square. It turns out that not a lot of people think that $50 in a pot managed by Ackman is worth $55, and there is only so much Ackman can do to persuade them otherwise. But some people think that the value of Pershing Square is $10 billion; putting the management company in the pot gives you something more subjective to market.

A third way to restructure the IPO is just literal structure. Like:

1. You buy a share for $50.
2. You also get a free warrant to buy another share for $50.
3. If the value of a share goes up to $70, you get to buy another one at a discount.

This strikes me as the least compelling option. For one thing, you are not really getting a discount to net asset value; you are just getting some different slicing of the same pot. For another thing, the mechanism of the warrant is something like “if all goes well, PSUS will sell more shares in the future at a discount to net asset value, diluting its shareholders,” which is maybe not what you want to sign up for. [1]

Anyway here’s an update from the Financial Times:

Ackman has discussed several options for the new structure, one of which would gift early investors in Pershing Square USA the right to buy extra shares in the vehicle in the future at a fixed price through warrants, two people familiar with the matter said.

However the real prize for investors in Pershing Square USA is likely to be rights to buy into the eventual IPO of his hedge fund, Pershing Square Capital Management, which manages investments for both the proposed US vehicle and his existing European fund. ...

Under the previous plans for the IPO, Ackman had sought to lure investors by waiving management fees for the fund’s first year of trading.

However during the marketing process, Ackman met resistance from investors who sought further incentives to invest in the IPO rather than waiting to buy shares after the launch, when such funds often trade at a discount. If warrants were issued alongside the Pershing Square USA stock, the structure might no longer include such a waiver, one of the people said. ...

Separately, two people close to the hedge fund said they expected Ackman to bring the Pershing Square IPO back to the market before the end of this year to keep up perceived momentum.

They seem to be landing on a combination of my second and third approaches: warrants, but perhaps warrants to buy the management company rather than just warrants to buy more shares of PSUS. And if the deal does include a slice of the management company, then the fee waiver is arguably less compelling: After all, the more money Pershing Square makes, the more valuable it is, and PSUS investors would share in that value.

A basic pattern for a lot of commodities companies is:

1. They mine, drill, produce, refine, etc., some commodity in physical markets, digging it up out of the ground and putting it on boats for customers who pay them for it.
2. They also trade financial derivatives on the commodity, for instance trading futures contracts on a commodity exchange.
3. They do the derivatives trades first: They sell a million barrels of oil futures at $80 to lock in a price today, then they drill the oil and put it on boats and sell it for cash at whatever the market price is when it arrives, and then they close out the futures contracts. If the price of oil when they actually sell it is $70, they get paid $70 for the oil and make $10 on the futures contracts (they sold at $80 and can buy back at $70), for a total of $80. If the price is instead $90, they get $90 for the oil but lose $10 on the futures contracts (they sold at $80 and buy back at $90), for a total of $80. 

This can be roughly characterized as “hedging”: The company has locked in the $80 price for its production, giving up upside (if the price goes up, it doesn’t benefit) to limit its downside (if the price goes down, it doesn’t lose money). But it doesn’t have to be only hedging. If the company thinks that oil prices will go down, it can sell more oil futures than it plans to drill. If it thinks that oil prices will go up, it can opportunistically buy oil futures. Its futures traders will have some leeway to make bets that they think are smart, rather than precisely reflecting its drilling plans, and its physical drillers will have some leeway to increase or decrease production for their own reasons, rather than precisely filling the futures position.

This can lead to trouble. We talked a few months ago about a US Commodity Futures Trading Commission enforcement action against Trafigura Group. Trafigura traded physical oil and also oil derivatives. In the ordinary course of things, it (1) bought oil futures to lock in a price, (2) went out and actually bought physical cargoes of oil to deliver and then (3) closed out the futures.

Sometimes, though, it would make bets on oil prices, by buying more oil through derivatives than it planned to actually buy in the physical market. And then it would go out and buy oil in the physical market. But its buying in the physical market affected the price of its oil derivatives: Oil futures settle against some benchmark oil price, and that benchmark is set by looking at actual physical oil transactions, and Trafigura was doing a lot of those transactions. And the higher the price that it paid in its physical transactions, the higher the price it would get on its derivatives. 

And so there is an incentive to pay higher prices. Like, most of the time, a trader will want to buy stuff at the lowest possible price, so she will take steps to buy discreetly and carefully and efficiently. And then sometimes a trader will want to buy stuff at the highest possible price — losing money on the trade, but making more money on a related derivative trade — and so she will take steps to buy sloppily and quickly and push up the price. And that is allegedly what Trafigura did: The CFTC said that its “heavy bidding and buying activity in that short period tended to increase prices paid in the [price setting] window, and ultimately contributed to an increase in the daily Platts USGC HSFO Benchmark value, which benefitted Trafigura’s long derivatives position.” 

And the CFTC said that was market manipulation and fined Trafigura $55 million. But, I wrote, “it’s a funny sort of manipulation”:

Trafigura was buying physical oil, in the quantities it needed, for a real economic purpose (to export it to Singapore). The buying was not itself manipulative. And it had those futures positions, in part, to hedge its price risk when it bought the oil. Given that, it made sense for Trafigura to buy during the Platts window: Its hedge was settled against the Platts window, so it should do its buying in the Platts window, to avoid any slippage between the hedge price and its actual buying price. So buying in the Platts window, to close out your Platts-based hedge, makes sense. 

But because the derivatives position was bigger than the physical one, and because Trafigura bought so heavily and pushed the price up, the CFTC thought it was manipulation. But there is no smoking gun. There was no email from one Trafigura trader to another saying “lol let’s push up this benchmark to get paid on our derivatives.” If Trafigura was doing entirely legitimate trading — hedging its price risk in futures, then buying physical oil and closing out its hedges — the trades would have been roughly similar. The CFTC just looked at the trades and decided they were not quite economic, that the size and timing and price impact of the trades were suspicious.

On Tuesday, the CFTC fined TOTSA TotalEnergies Trading SA $48 million for a similar sort of manipulation, this time in the market for EBOB, “a type of refined gasoline used primarily in automobiles in Europe.” (Here is the CFTC’s order.) TOTSA trades in the physical market, blending and selling EBOB gasoline, and also in the derivatives market, trading EBOB futures on the New York Mercantile Exchange and Intercontinental Exchange. In March 2018, a TOTSA trading desk in Geneva — called “the LIGHTS desk” — “established a large short position in EBOB-linked NYMEX and ICE futures for March”:

These March-settled futures contracts were priced off of the Argus EBOB Benchmark. Because TOTSA’s position in these futures was a short position, meaning that it would increase in value if the price of physical EBOB declined, the LIGHTS desk knew that TOTSA’s futures position would be worth more if the reported Argus price of physical EBOB during the month of March was lower.

The LIGHTS desk established this short position in EBOB-linked futures not just to hedge TOTSA’s physical product, but as part of an effort to make money by speculating on the price of physical EBOB. The short position was large enough that the financial benefit to TOTSA, if the price of EBOB was lower during March, could potentially more than offset any lost revenue a lower physical price might cause TOTSA to incur on sales of physical EBOB. Consequently, TOTSA would likely benefit financially, overall, if EBOB gasoline was sold at lower prices during March. The lower the average Argus reported price of EBOB was during March, the greater would be the potential financial benefit to TOTSA from its short position in futures.

Again: TOTSA planned to physically blend and sell EBOB gasoline, but it first sold EBOB through futures. And, says the CFTC, it sold more EBOB in the futures market than it planned to sell in the physical market. So it had an incentive to sell the physical gas cheap. And it did:

In March 2018, TOTSA was well-positioned to attempt to depress the price of physical EBOB, and potentially increase its overall trading profits, because TOTSA is one of the largest participants in the EBOB market, and has the capability to blend and sell thousands of metric tonnes of gasoline daily. Throughout March 2018, TOTSA sold more physical EBOB than it had ever previously sold in a single month. The volume of EBOB that TOTSA sold in March constituted more than 60% of the reported volume transacted by all brokered market participants. …

On multiple days in March, TOTSA traders repeatedly attempted to sell physical EBOB at prices lower than the prices other market participants had indicated they were willing to pay. ...

On March 2, 2018, in chats with EBOB brokers, a TOTSA trader (Trader A) transmitted an indicative offer to sell winter-grade EBOB, and subsequently refused to sell at a higher price, even after another market participant indicated that it was willing to buy at a higher price. A broker specifically told Trader A that another market participant was willing to buy winter-grade EBOB for $2 more per tonne, and asked if TOTSA would sell at the open for this higher price. Trader A indicated that TOTSA did not want to sell at this higher price, and reiterated TOTSA’s previously expressed lower price. …

On March 12, 2018, in a chat with an EBOB broker, a different TOTSA trader (Trader B) communicated an indicative offer to sell winter-grade EBOB, and was subsequently informed that another market participant was interested in buying winter-grade EBOB for a price that was (depending on specifications relating to delivery) either $4 or $9 per tonne higher than the price at which TOTSA was attempting to sell. TOTSA Trader B initially responded by indicating that TOTSA was not interested in selling winter-grade EBOB at either of these higher prices. Trader B also emphasized that TOTSA’s offer to sell at a lower price was “valid.” ...

On March 16, 2018, in a chat with an EBOB broker, TOTSA Trader B communicated an indicative offer to sell winter-grade EBOB, and was subsequently informed that another market participant wanted to buy winter-grade EBOB for $3 more per tonne than the price at which TOTSA was seeking to sell. Trader B asked the broker to call him and, shortly thereafter, the broker sent a WhatsApp message to Trader B stating that he had spoken with the other market participant, and that the other market participant was now prepared to buy at TOTSA’s lower price.

“Accordingly,” concludes the CFTC, “TOTSA on multiple occasions during March, 2018 intentionally or recklessly attempted, through its sales of physical EBOB, to manipulate EBOB-linked futures contracts.” 

Here again there are no smoking-gun emails saying “let’s manipulate the price,” though to be fair that is in part because “TOTSA did not timely produce certain WhatsApp communications [the CFTC] requested or adequately preserve these communications.” There is just the CFTC’s analysis that TOTSA was selling its gasoline too sloppily, getting prices that were too low because that helped its derivatives position. And the somewhat smoking-gun-ish chats where the TOTSA traders turned down higher prices: If you are selling gas and someone is like “I’ll pay you $100” and you are like “I’d prefer $96,” that does suggest that you’re up to something.

Still, CFTC Commissioner Caroline Pham dissented from the enforcement action, writing:

This case is a textbook example of policymakers with no industry experience second-guessing commercial business decisions in a bubble. It is undisputed that there is no evidence of artificial prices in this case. Instead of accepting that, the CFTC has once again brought the immense power of the U.S. government to bear down and obtain a settlement by misapplying the CFTC’s broad Dodd-Frank anti-fraud and anti-manipulation authorities. Far from using these new authorities as intended to go after abusive trading practices in the swaps market, the CFTC instead has used them as a blank check to go after commercial producers and merchants in the cash markets. This approach is the opposite of the CFTC’s original mandate to promote price discovery and hedging in commodity markets, and will actively discourage commercial end-users from appropriately managing their risks with the use of exchange-traded futures. ...

The direct evidence that was contemporaneous with the alleged manipulative activity does not support the charges, and is consistent with both later expert analysis and the CFTC’s own internal analysis regarding physical gasoline market fundamentals underlying supply and demand and Respondent’s trading activity.

I mean, I am inclined to agree with the CFTC that refusing to sell the gas at higher prices is some “evidence of artificial prices.” Still I think Pham has a point. These cases involve physical market participants legitimately buying and selling their products, while also having derivatives hedges that don’t quite match up with their physical positions. That basic pattern is fine. It’s market manipulation only if they are buying and selling the products uneconomically, with the intent of manipulating the benchmark to make money on their derivatives. Maybe they are! But if they don’t say that, the essential evidence of manipulation is that the CFTC thinks their trades were sloppy and bad. The CFTC has some expertise here, so I’m not sure it’s quite “a textbook example of policymakers with no industry experience second-guessing commercial business decisions in a bubble.” But it is a little weird for the CFTC to fine commodity traders for trading badly, and the traders probably do know more about trading than the CFTC does.

A company is a nexus of contracts. If you are an employee or customer or supplier or landlord or creditor of a company, you generally have some sort of contractual relationship with the company. You entered into that relationship for a reason: You met the company’s employees and sampled its product and signed up for some sort of deal with the company.

Sometimes companies are acquired in mergers or acquisitions. The buyer of the company is, essentially, buying its contracts. That’s what there is; that’s what the buyer is buying: The employees, supply chains, buildings, customer relationships, etc., are the target company.

This can create problems. A classic one is:

1. You signed a contract with Nice Company A, because it is nice, and because you hate to deal with Giant Company B.
2. Giant Company B acquires Nice Company A.
3. Now your contract is with Giant Company B.
4. That is not what you wanted.

You might try to address this problem in advance, by saying in your contract with Nice Company A “this contract will terminate if you are acquired by someone else.” But this is weirdly difficult. On the one hand, of course you want the flexibility to get out of your contracts if your counterparty gets acquired by someone you don’t like. On the other hand, if everyone could get out of their contracts on an acquisition, companies could never be acquired: Nice Company A is its contracts, and if they all disappeared when it was acquired, then nobody could acquire it.

And so we have talked about a weird dispute involving an oil joint venture between Hess Corp. and Exxon Mobil Corp. Exxon manages the Stabroek block, a giant oil field in Guyana that it co-owns with a few other oil companies, including Hess. There is a contract, a joint venture agreement. Then Hess signed a deal to be acquired by Chevron Corp. Exxon says that Hess is not allowed to transfer its Stabroek stake to Chevron, including in a merger, so Exxon should get to buy it back. Hess and Chevron say, no, of course Chevron is allowed to buy Hess, and if it buys Hess then it gets its stake in the Stabroek field. There seems to be a real dispute about how the contract works. Plausibly Exxon really thought that Hess was not allowed to be acquired and keep its Stabroek stake, while Hess really thought that was allowed.

Another problem is:

1. Small Company X is up for sale.
2. Big Company Y expresses interest in buying it and asks to do due diligence.
3. Small Company X puts all of its contracts and other information in an online data room, so that Big Company Y can get a sense of what it is buying.
4. Big Company Y takes copious notes on all of Small Company X’s sensitive contracts.
5. It does not buy Small Company X.
6. It does, however, call up all of Small Company X’s customers and offer them a slightly better deal.

This is not allowed — generally the data room will be subject to a confidentiality agreement — but it could happen anyway. We have talked about a lawsuit brought by Propel Fuels Inc. against Phillips 66 Co., claiming that Phillips 66 considered buying Propel, entered into confidentiality agreements, got access to a data room, learned all about Propel’s business, and then abandoned the deal and decided to compete with Propel instead.

Here’s an even weirder case:

A New York court has ordered Evercore to reveal who had access to a confidential document the investment bank posted in an electronic data room, the secrecy of which Arizona Beverages said was essential to maintaining the 99 cent pricing of its “Big Can” iced tea.

Arizona initiated legal proceedings against Evercore this spring, accusing the boutique firm of wrongfully uploading a secret supply agreement between the upstate New York-based tea maker and its can supplier, Vobev, which Evercore had been hired to sell.

Vobev makes the cheap cans for Arizona, which are apparently crucial to its business. Arizona and Vobev had a supply agreement that was apparently super secret. Vobev considered selling itself, and as part of the due diligence for the sales process, of course potential buyers wanted to see its contract with a big customer like Arizona. So it (or rather its bankers at Evercore) put the contract into the online data room, where the buyers could look at it. And the buyers might or might not have included Ball Corp., “Arizona’s other major supplier and a previous client of Evercore”:

“If AriZona is unable to obtain Big Cans for distribution on the West Coast at the contracted price under its Can Supply Agreement with Vobev, AriZona will suffer millions in damages and Ball will gain enormous leverage over the supply of Big Cans to AriZona, especially if Vobev is sold to Ball,” Arizona later wrote in a court action seeking to uncover the parties that had seen the confidential document. 

Evercore denied it had shown the agreement to Ball and said its own confidentiality obligations rendered it unable to reveal the unnamed third party “A” that had entered the data room. 

I suppose that, from Arizona’s perspective, it is bad if Ball sees the Vobev/Arizona supply agreement: That would give Ball some competitive information that might give it more leverage over Arizona. But it’s perhaps even worse if Ball buys Vobev and takes over the Vobev/Arizona supply agreement.

Yesterday, a few hours before Nvidia Corp. reported its earnings, I asked: “If you worked in Nvidia Corp. investor relations, and you have the earnings a day early, and they are a surprise to the upside, what should you do with that information?” I suggested that (1) buying Nvidia stock or options would be a bad idea (insider trading), while (2) making macro bets on the broad US stock market would be at least an entertaining idea. (“Shadow trading,” but also a reflection of Nvidia’s macroeconomic importance. Not legal advice!) That answer turned out to be weirdly correct. Bloomberg’s Carmen Reinicke and Jeran Wittenstein report:

Nvidia Corp.’s earnings report needed to be perfect for a stock that’s added nearly $2 trillion in market value in the past year. In the end, a broad beat still sparked a selloff.

At issue is Nvidia’s revenue forecast. While easily exceeding the average analyst estimate, the beat was far narrower than investors have grown to expect over the past five earnings reports. That, and an acknowledgment that the new Blackwell chip hit production snags, was enough to send Nvidia shares tumbling in postmarket trade Wednesday, with declines resuming in premarket Thursday.

Nvidia beat earnings estimates, but if you knew that in advance and bought the stock, you’d have lost money. Meanwhile if you had been like “Nvidia is going to beat estimates, so I’ll buy the S&P,” you did fine: The broad market was up this morning, even as Nvidia was down. Nvidia turns out not to be a particularly reliable macro indicator, but also, published Nvidia earnings expectations turn out not to be particularly reliable indicators of the market’s actual expectations.

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