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Absolute Return Podcast #17: SEC Goes After Crypto

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June 10, 2019–Trump Says He’ll Drop Mexican Tariffs As Countries Reach Deal On Migrants. Is a Deal With China Next?

Messaging App Startup Kik Interactive Sued By SEC Over $100 Million Cryptocurrency Offering. What Did They Do Wrong?

Canadian Unemployment Rate Hits Record Low As Canadian Economy Added More Jobs Than Expected In May. But Is The Economy Healthy?

U.S. Jobs Disappoint As The Economy Only Adds 75,000 Jobs In May. What Happened?

Transat Gets An Overbid From A Real Estate Developer. Is This A Legitimate Bid?

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Transcript

Welcome investors to the Absolute Return Podcast. Your source for stock market analysis, global macro musings and hedge fund investment strategies. Your hosts Julian Klymochko and Michael Kesslering aim to bring you the knowledge and analysis you need to become a more intelligent and wealthier investor. This episode is brought to you by accelerate financial technologies. Accelerate because performance matters. Find out more at www.Accelerateshares.Com.

Julian Klymochko: Welcome investors to Episode 17 of the Absolute Return Podcast. I your host Julian Klymochko

Michael Kesslering: and I am Michael Kesslering.

Julian Klymochko: Today is Saturday June 8 2019. A lovely Saturday I just got back from Toronto on Friday, got to open the stock market which was fun. I did an interview on BNN as well so if you have not seen that go on check that out. Obviously, Toronto is really happening these days with the Toronto Raptors potentially winning the NBA championship. Shortly they are up 3 to 1 against the Golden State Warriors so hopefully they can take that championship on Monday, but let’s get into it a lot of interesting events happening this week. Let’s start off the top.

  • On Friday night, Trump tweeted that he will drop Mexican tariffs as the countries reached a deal on migrants with Mexico. We will talk about what happens next.
  • Messaging app start up kik interactive. They got sued by the SEC for their hundred million dollar cryptocurrency offering. We will talk about what they did wrong.
  • Talking jobs this week Canadian unemployment rate it is a record low as the Canadian economy added more jobs than expected in May. We will talk about what is going on in the Canadian economy there. In addition to that, U.S. jobs numbers came out as well but they disappoint into the downside with only 75000 pretty significant miss on those numbers. We are going to talk about what happened exactly there.
  • Finally, we will talk about Transat. They got an overbuild or what seems like an over bid a higher bid than what was previously mentioned from their offer from Air Canada, but we will talk about is that a legitimate bid?

Big news on the trade war front. Last week’s episode we talked about a potential second trade war between the U.S. and Mexico but what happened last night on Friday. Trump says he will drop Mexican tariffs as the countries reached a deal on migrants. We have a fresh tweet last night from President Trump. He stated quote “I am pleased to inform you that the United States of America has reached a signed agreement with Mexico. The tariffs scheduled to be implemented by the U.S. on Monday against Mexico are hereby indefinitely suspended”. He also stated everyone very excited about the new deal with Mexico. I believe that tweet was this morning along with this one. I would like to thank the president of Mexico Andres Manuel Lopez Obrador and his foreign minister Marcello Ebrard, together with all of the many representatives of both the United States and Mexico for working so long and hard to get our agreement on immigration completed exclamation point.” I would be remiss if I did not mention that he tweeted out that the Dow Jones had the best week of the year. What are your thoughts on this?

Michael Kesslering: Yes, so the U.S. has been demanding Mexico to begin detaining asylum seekers and increasing security at the Mexico, Guatemala border. They have demanded this for a while now but it has been reported that Mexico has already agreed to do this. What remains unclear is whether these are new and broader concessions or if it is really just like a face saving deal with no changes made. Now after he had second thoughts on tariffs and the pushback from Republicans so it is a little unclear as of as of right now. One interesting stat is that Bloomberg estimated that an all out trade war between the U.S. and Mexico could lower global GDP by about point eight percent by mid-2021.

Julian Klymochko: To get into it what the U.S. was demanding here – was Trump’s specifically because I know a lot of Republicans and even his own advisers really were against him on this one. He demanded that Mexico began detaining asylum seekers that were coming up from Central and South America through Mexico. Seeking asylum in the U.S. while beefing up security at the Mexico Guatemalan border and at checkpoints throughout Mexico between its southern and northern borders. What he was planning on implementing was a 5 percent tariff on all Mexican imports to the U.S. He indicated that that could increase to 25 percent by October. The two administrations worked to get this deal done and as you say perhaps a face saving move. Once he realized that he tanked the market last week when clearly that is very important to him. His supposed score card and probably on the advice of many within his administration that this was not in fact a smart thing to do for the economy.

Michael Kesslering: Yeah absolutely and it was something that we had kind of brought up last week. There is always the potential that Trump sees how the market reacts and then completely changes course. That has kind of played out from our prediction a week prior.

Julian Klymochko: Yeah exactly, but bottom line there is not going to be a second trade war. It seems Mexico is safe and I guess Canada would be safe as well and the USMCA likely to get ratified, leaving free trade between those three nations as is.

Interesting news in the crypto space. What happened here was a messaging app start up kik interactive. They are based out of Waterloo Ontario Canada. They got sued by the SEC over their hundred million dollar cryptocurrency offering. They did an ICO in 2017 offering a crypto called kin to investors, looking to raise money. What happened in April, the SEC published a framework to help determine whethe, or not digital assets, basically crypto currencies, are securities. This framework cites a U.S. Supreme Court case referred to as the Howie case. This is where the Howie test comes from where they determine whether or not something is a security.

This determined that an investment contract exists whenever there is an investment of money in a common enterprise with an expectation of profits to be derived from the efforts of others. Those three tenants make whether or not something is security. Obviously here, the SEC is claiming that can this cryptocurrency that kik did raise money selling. Is a security and kik claiming that it was in fact not, statement from the SEC quote “kik told investors they could expect profits from its effort to create a digital ecosystem, future profits based on the efforts of others is a hallmark of a securities offering that must comply with the federal securities laws.”

Some details here. Kik sold one trillion of its kin tokens to more than 10,000 investors around the world in 2017. Kik said it planned to integrate the token into its chat app and use the money raised to create a new ecosystem of digital services. The company did not register the token offering with regulators obviously and this is why it is coming back at them now. Investors did not receive the types of disclosures legally required in a securities sale. When you are selling stock obviously, you need to provide certain disclosures required from the regulator such as prospectus financial statements and whatnot but obviously Kik and other cryptocurrency is did absolutely none of that. Ironically, Kik is launching a five million dollar crowd funding campaign to mount a legal defence against the SEC in court trying to defend themselves here. Lastly, I wanted to mention a quote from SEC Chairman Jay Clayton on his views on ICOs. He stated quote “I believe every ICO I’ve ever seen is a security.” What are your thoughts on this one?

Michael Kesslering: Yes, so really this comes down to the difference between a currency and a security. So you’d mentioned the definition of a security that the SEC has but what kik arguing is that they’re tokens value doesn’t come from investment value but from its use as a currency as their stated goal is to grow the kin economy where people can use their kin as currency to buy goods and services. The SEC case is arguing that their marketing efforts were focused on price a price appreciation of the kin tokens not in its potential as a medium of exchange. There are other interesting allegation is just in terms of structure. Is that the Kin token was built on the theory of network known as an ERC 20 token and there kind of analysis as, said that at that time that the Ethereum network would not have been able to handle the type of scaling transactions that Kim had discussed with their kin economy.  It really provides credence that really all they were focused on was using this as security. Getting investors to invest in the security on the basis that the token would go up in value. When you are looking at this case why we are even discussing it is that this really could be a landmark case as there has been thousands of these ICO and this could be the next case if it goes through. That a referenced for the rest of these ICOs.

Julian Klymochko: Certainly many in the cryptocurrency space, if you did an ICO you are definitely watching your back now because if this goes against them which I think is highly probable then everyone’s going to kind of get taken down for what they did. I am going to tell it like it is so Kik was a start-up that was formerly a unicorn. I believe at one point they were valued at a billion or higher in a financing round and they were not doing so well lately. Their user base was actually dropping. They were highly unprofitable, burning cash and effectively ran out of money. No VC was going to invest more money in a declining enterprise and at a valuation at a small fraction of what they were worth before.

They are basically a dead company. They have tried selling it and it went no bid. No one wanted to buy it, so the CEO had hatched kind of Hail Mary plan to capitalize on the crypto hype to raise money for his company. The way I view it is the one and only reason that they issued this kin was to get money into their coffers because they were going to go bankrupt. With that in mind, clearly this absolutely was a securities offering. You cannot say it was anything but there was zero ecosystem when they sold this kin security or kin cryptocurrency. I think they are going to have a real tough time defending it. Ironically, they launched a crowdfunding campaign and it’s being promoted ostensibly by one of their directors who’s a fairly prominent VC. I view that as more him trying to bail out a portfolio company of his. They clearly spent all the money, not only that they previously raised but all the money that they raised in this cryptocurrency offering they cannot even afford their own legal defence. They are looking to raise 5 million from other investors. Obviously if you are a crypto type investor then you want the SEC not to win a landmark case here. I am assuming that is why they are doing it, but clearly, I think that the SEC is right on this one, and kin is a security.

Michael Kesslering: Absolute and in terms of the crowdfunding campaign as well they are accepting cryptocurrency for the crowdfunding campaign which is another interesting aspect of all of this.

Julian Klymochko:  Crypto that has declined a lot in value.  I looked at what they had in their wallet and a good chunk of it once kin which is kind of ironic where investors ploughing it back to them after they sold it initially and it declined in value, probably 95 percent or so.

Let’s get into the jobs numbers that came out this week. Canadian unemployment rate hit a record low as the Canadian economy added more jobs than expected last month in May. Getting into some numbers here the Canadian economy showed some green shoots in May as it added twenty seven thousand seven hundred jobs in the month. Easily exceeding the average economists forecast of only an eight thousand increase. Pretty significant beat there, the unemployment rate in Canada fell to five point four percent, which is a record low. The better than expected increase in the number of jobs made up entirely of full time employment. There is no change in the number of part time jobs followed a record hundred six thousand five hundred jobs that were recently added to the economy from a jobs point in Canada really hitting an on every cylinder there. The Canadian economy posted its weakest back-to-back quarters in contrast of growth since 2015 in Q4 and Q1. Contrast that incredibly strong jobs growth have a relatively weak GDP growth it is quite the conundrum for economists. TD Bank senior economist Brian DePratto stated quote “recent communication from the Bank of Canada attributed weakness in hours worked to caution among employers. That caution clearly remains, and with some trade uncertainty elevated expect the Bank of Canada to stay on the sidelines for some time.”

Getting into the numbers. Reasonably, Ontario accounted for more than 20000 of the jobs in BC saw an increase of sixteen thousand eight. Ontario and BC the main winners there. Newfoundland, Labrador a really struggling with some lost jobs. Interesting dynamic here you have incredibly strong jobs reports not just one month but many jobs reports in a row in Canada. Contrast that to couple of quarters of fairly weak economic growth. We are talking pretty close to recession level GDP growth. It is an interesting quandary for the Bank of Canada. They are dealing with relatively low inflation numbers as well and typically, when the jobs market is so strong you have higher inflation. They are steadily raising rates, but here I mean they’re getting mixed signals. I would say at the Bank of Canada, where your thoughts on the latest jobs numbers?

Michael Kesslering: Yes, I first wanted to bring up that I think I had mentioned this with the last numbers is that the hourly wage growth is continuing its trend upwards so it is up at 2.8 percent growth year over year up from 2.5 percent in April. You are seeing nice hourly wage growth, which is a key indicator that the Bank of Canada does watch, but as well on the unemployment side is that number is a little finicky as it obviously is impacted by the job gains over the month. Also there is a decline in the labour force participation rate. It actually is down from sixty five point nine percent at the beginning of the year or month over month down to sixty five point seven percent. There was a decrease of 50,000 jobs or a decrease in the labour force of fifty thousand.

Julian Klymochko: Right, which could lead to the decline in unemployment rate, but it, is not a good thing just because people are leaving the labour force you want to see the unemployment rate declining in a healthy economy based on job creation and more people working not people are giving up or just leaving the workforce. This provides a good transition a contrast to things extremely positive Canadian jobs numbers.

Big disappointment in the U.S. they added only 75,000 jobs in May; non-farm payrolls were expected to be 180,000 increase in jobs. That was the average economists forecast – a pretty significant miss on the U.S. jobs numbers and this comes at the end of quite a pretty significant run that they’ve been on. Obviously, the U.S. economy has been doing very well. Pretty much since the economic expansion started in 2009. Now this disappointing job growth number was the lowest since the economic expansion began. Just to give you some context on how disappointing this number was. We have had consistent reports that 200,000 or higher or so to get only 75,000 is quite a disappointment. It is a big contrast to April when the non-Farm private sector, added a stunning two hundred and seventy one thousand jobs, quite the contrast there between U.S. and Canada. We always caution that you should never take one data point. Potentially this U.S. number is an outlier but that is to be seen. Any more thoughts on that the U.S. jobs report here?

Michael Kesslering: Yeah. In terms of the U.S. jobs, growth it is predominantly in large business, businesses with over 500 employees. It is really showing that small businesses are having some struggles in attracting workers. Is similar to Canada, they are actually having a decline in their labour force participation rate. That is an impact as well, but the labour shortages really could impede some of the job growth moving forward, which will be interesting to monitor. On the other side, they are having average hourly earnings increasing well above inflation I believe it was just over 3 percent year over year. The earnings power of the populace is increasing so that should have some flow through effects into the GDP numbers in terms of the consumer spending side.

Julian Klymochko: There is an interesting dynamic between economic data figures and the stock market. I feel like this number was the bad news, is good news. Bad economic news is good news for the stock market because we had a negative jobs report and market participants think that the Fed might be more likely to ease based on that big miss in jobs numbers. The probability of a rate hike from the Fed is actually increasing dramatically. They are even talking about a potential rate cut this month. Those probabilities, those odds creeping up and I believe a probability of a rate cut this year in 2019 is nearing 100 I think. It is north of 90 percent so the market is really focused on not just kind of weakening economic figures but what is the Fed going to do about that and how can they help this expansion going. How can they help the market to keep going up and make new all-time highs?

Michael Kesslering: Yeah, I think the so the exact numbers in those situations for their probability of a rate hike as of Friday. It had increased from 20 percent chance in June to 35 percent and then in terms of a rate hike in July at that meeting. It is now at 80 percent, so there is potential for potential for two rate hikes or a cut.

Julian Klymochko: Moving on to some M&A, merger and acquisition news. Transat catching an over bid or a potential over bid from a Quebec-based real estate developer called group Mach Inc. This real estate developer announced last week that they are seeking to acquire Transat for fourteen dollars per share. Potentially topping Air Canada’s previously disclosed friendly thirteen-dollar offer for Transat. The would be acquirer went public with its fourteen dollar bid and they indicated that it is contingent on getting a one hundred and twenty million in financing from Quebec’s investment. Which is quite the contingency, quote here from Premier France Legeault.

He stated, quote “we said at the beginning that we were concerned there would be an offer that came from outside Quebec and that we were ready to help a Quebec group to put place an offer. Now we have two Quebec groups”, he is referring to both Air Canada and group Mach. “I don’t think the government necessarily has to get involved. If there is, a good proposal and an attractive investment for Gestim Quebec, which is their provincial fund. They can look at that but I don’t see the urgency here given we’re talking about two Quebec companies.” There you have it. That is right from the mouth of the government pretty much saying we are not providing you that financing. Quote from the CEO of Group Mach Vincent Chiara. “With respect to talks with the Quebec, government regarding this funding stated they are quote ongoing.” They said they would provide that type of financing if they were satisfied with the business plan which will submit to them. This is the key, he stated. “They were not opposed to the idea,” and that is pretty much the most bullish, he has to be on this. What are your thoughts on it?

Michael Kesslering: You mentioned that the Quebec government will be required to provide acquisition financing of 120 million, which is likely to be politically unpopular. The other aspect is that another condition is voting agreements with a couple of the large shareholders of Transat. CAISSE and FSTQ, which you know is, is just another difficult hurdle to get around. What will be interesting to look at here is that Mach plans to keep the management team in place and so it will be interesting to see what the management team and board views of that as there could be some self-preservation involved as the potential with an Air Canada merger. Those jobs likely would be part of the synergies. They are also committing to no layoffs which I’m not sure if Air Canada had committed to but that could be one aspect that the government in Quebec looks at and if they view the potential for no potential layoffs that could be very well viewed very positively.

Julian Klymochko: Right so a few things to touch on here. Number one is just the financing I mean to get one hundred and twenty million dollars, that is very sketchy especially when you have a quote from the premier here saying look we’re not giving you this money. I do not view this 14-dollar bid as a bonafide offer. It is clearly just a Hail Mary pass; I think it is highly unlikely to be anything legitimate. Transat now trading through the terms of Air Canada’s 13-dollar offer it is trading at $13.40. So clearly some market participants believing this, I definitely caution investors against this 14-dollar offer. As I said, it does not seem legitimate just because look they do not have the money when you do not have the money you can do a deal and that is that.

The other thing is going for Transat that you have seen some pushback from big shareholders there Transat has a lot of cash on their balance sheet. They do have real estate assets specifically that hotel and land that they are building in Mexico. This big development this Mexican development, from a sum of parts perspective. I have heard shareholders looking for more fifteen, sixteen dollars per share as opposed to the $13 another offer, from a sum of parts basis. This thirteen dollars pretty much pays for the cash on Transat balance sheet along with their real estate assets, really not paying anything for the airline. Some investors pretty upset with $13; they say it is too low. However, the premium was in the triple digits. I believe Transat was trading in kind of the six-dollar range prior to this deal coming through. Kind of hard to turn down a triple digit premium takeover on that side.

Then another interesting dynamic against the Air Canada bid is just from a competition perspective we talked about it on a previous podcast just the anti-trust risks with respect to that. Obviously, competition is a major concern because they are consolidating the number one and the number three player. They have very high concentration of market shares in certain segments of the business. The Competition Bureau is going to take a very close look at that deal. Who even knows if it is going to be approved. That could be one positive for this 14 dollars per share offer, so there is that. Ultimately, I would not put a lot of faith in that coming through.

Air Canada still trying to complete their due diligence on Transat. Settle, a definitive agreement shortly, but you also mentioned synergies and jobs. I think that Air Canada is probably going to bank on some synergies and by synergies we mean, job losses. Job cuts getting rid of some overlapping people. There is another dynamic you know how Quebec loves their jobs but at least the Air Canada is another Quebec based company. I don’t believe this one should get very political.

Michael Kesslering: And in terms of these shareholders views the ones that I’ve read is basically their view is just that this bid would undervalue the company and that they would recommend looking to sell the company after it returns to profitability and after they execute some of their strategic plan moving forward. They aren’t just saying that they’re not willing to do a deal it’s just that they feel that this is perhaps isn’t the best time to look to sell the company right.

Julian Klymochko: That about wraps it up for the Absolute Return Podcast. I hope you guys enjoyed this episode. You can find out more at absolutereturnpodcast.com if you like it leave a review. You can catch us at all the other major podcasting apps. Apple Music, Spotify, Google Play. That is it for us and we will chat with you next week, cheers.

Thanks for tuning in to the Absolute Return Podcast. This episode was brought to you by accelerate financial technologies. Accelerate, because performance matters. Find out more at www.AccelerateShares.com. The views expressed in this podcast to the personal views of the participants and do not reflect the views of Accelerate. No aspect of this podcast constitutes investment legal or tax advice. Opinions expressed in this podcast should not be viewed as a recommendation or solicitation of an offer to buy or sell any securities or investment strategies. The information and opinions in this podcast are based on current market conditions and may fluctuate and change in the future. No representation or warranty expressed or implied is made on behalf of Accelerate as to the accuracy or completeness of the information contained in this podcast. Accelerate does not accept any liability for any direct indirect or consequential loss or damage suffered by any person as a result relying on all or any part of this podcast and any liability is expressly disclaimed.