April 13, 2020—The Fed Announces Unprecedented $2.4 Trillion in Loans to Support Local Businesses and Governments. What are the Implications of This Massive Stimulus?
Airbnb in Trouble as it Withdraws IPO Plans and Completes a Distressed Financing. Will the Company Survive?
Not all Heroes Wear Capes: Jack Dorsey Pledges $1 Billion in Fight for Coronavirus Cure.
Value Sucks Wind While Momentum Surges. A Discussion of March Factor Performance.
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 62 of the Absolute Return Podcast. I am your host, Julian Klymochko.
Michael Kesslering: And I’m Mike Kesslering.
Julian Klymochko: Today is Friday, April 10th at 2020. A few really, really cool things happening in the markets this week that we wanted to discuss.
- Firstly, the Fed announced an unprecedented 2.4 trillion dollar stimulus package that includes loans to support local businesses and governments. We are going to discuss the implications of this massive stimulus and involves the market going up last week,
- AirBnb, they are in trouble as they withdrew their IPO plans and they completed a highly distressed financing. We are going to talk about the details on that financing and whether that company will be able to survive in the age of Coronavirus.
- Not all heroes wear capes. Jack Dorsey pledged one billion dollars of his net worth in a fight to find a coronavirus curse.
- Lastly, we are going to discuss March factor performance value stocks win, but momentum surged. We are going to chat about the numbers there.
THE FED ANNOUNCES UNPRECEDENTED $2.3 TRILLION IN LOANS TO SUPPORT LOCAL BUSINESS AND GOVERNMENTS
Julian Klymochko: But for now, we really got a touch on what the Fed is up to. They announced this massive 2.3 trillion-loan program really to help kick-start the U.S. economy.
This is their second round of stimulus that the Federal Reserve unveiled. This latest one, some of the details. So 2.3 trillion, 600 billion of which is loans directly to small and medium sized businesses. Another half trillion going into local governments, I believe specifically by buying municipal bonds, and some of these local governments have really just been decimated because they’ve seen tax revenues just collapse. Unemployment rising, businesses are shutting under these social distancing rules. But I mean, their costs are always there. Right. The other thing is what the Fed is doing with its capital and how they are getting that into the hands of businesses and governments.
Well, a lot of that involves open market purchases of various securities. Specifically, they are expanding what they can buy. Historically, they are quantitative easing. They are buying mortgage backed securities and treasury securities, treasury bonds, treasury bills issued by the U.S. government. However, now they are going way outside of their previous mandate, such that we spoke about a couple weeks ago, how they could now start buying corporate bond ETFs. They expand that even more such that now they can buy municipal bonds; they can buy high yield bonds, that is right, junk bonds, and even junk bond ETF. Now, a note on the junk bond purchases. Specifically, they indicated that they would buy bonds of “fallen angel companies.” Now, what fallen angel bonds are, they are basically junk bonds, non-investment grade bonds that were previously investment grade, but got downgraded over this latest recession, so those are some of the details, like one example would be Ford.
And if we look at the market action on Friday, Ford bonds just absolutely surged on this news. And ultimately, the Fed’s program here, they’re looking to pump in support as much as eight hundred and fifty billion dollars into the credit markets. And in terms of the amount of fallen angel bonds expected this year, well, analysts at Citigroup expect about two to three hundred billion dollars of coming downgrades.
That is bonds that were rated investment grade, but will be getting downgraded to junk status this year, which is basically double the prior record from 2002 and some market action on these moves from the Fed. Obviously, risk assets, investors loving it. So the implications are, at least in the near-term, security prices are going up. If we look at the junk bond ETF, it rallied, what, seven percent on Friday, so a massive rally. Stocks, bonds, junk bonds, corporate bonds and municipal bonds. Everything getting bid up so certainly it has changed sentiment pretty dramatically when you have this buyer of last resort with seemingly unlimited money, 2.3, 2.4 trillion dollars coming into the market from the Federal Reserve. Investors certainly loving that liquidity coming into the market. What are your thoughts on that? What do you think the implications are from this pretty much unprecedented stimulus?
Michael Kesslering: Yeah, the implications are really. I mean, it is just a very unique scenario where I guess this is what happens when interest rates are at zero bound. They have limited options in terms of, you know, they can’t just lower interest rates and have the same effect. It is kind of like pushing on a string and so they have to do things like this. It is a very interesting scenario where, you know, a really good argument could be made that investors in overleveraged companies taking unjustified risks are being unjustly rewarded with this action by the Fed.
Julian Klymochko: Well, the other complaint are companies that have executed a significant amount of share buybacks over the past 10 years. There has been a substantial increase in share repurchases and now they are going out hat in hand to the government saying, oh, we have no money, we have no liquidity. We are going to have to fire everyone, and go bankrupt.
Michael Kesslering: Yeah and that is just not at all what happens in a chapter eleven. I should not say not at all, because some businesses do go bust and actually do leave industry. But I guess the airlines are a good example of, you know, if they go through chapter eleven. Yes, equity holders likely get wiped out, but the assets themselves still do have value and will still be operational, there still will be airlines. It is just a matter of who owns these and I guess I would go back to this week, Chamath Palihapitiya from Social Capital. He actually had a really good interview, I believe it was on MSNBC, but he talked about how companies should be allowed to fail, and just because a company fails doesn’t necessarily mean that it won’t exist. Exactly like I just mentioned.
Julian Klymochko: Yeah, by failure you mean bankruptcy, which implies generally a restructuring, not a liquidation but restructuring, typically involves the conversion of debt into equity. And so the company reorganizes and comes out brand new with significantly fewer liabilities and better capitalized to really start executing again. So it’s really just a temporary thing. Typically, they retain most, if not all employees, and then it is mostly the equity holders and stockholders and sometimes the bondholders who take a hit. Right.
Michael Kesslering: Yeah, absolutely and so, yeah, like you had mentioned, it’s a short term situation where it’s really just a matter of the owner of the business who owns the business after they go through the restructuring. This is a situation where as an investor; I very much like these moves by the Fed. They bring up risk assets, as you had mentioned. Working at an investment fund, that is a very good thing for any investor. But in this situation, it’s just trying to separate, you know, I guess my own views as an investor with my views of how a capitalistic society should work and this being great for investors, but in terms of a capitalistic society, capitalism really only works if companies are allowed to fail. If you can’t fail as a company, if you could just, you know, do share buybacks, which I have absolutely no problem with buybacks.
Julian Klymochko: We love buy backs.
Michael Kesslering: Yes, absolutely. Absolutely. Its part of our shareholder yield that we get as investors along with dividends. But using that capital, leveraging yourself to do buybacks and then coming to the government looking for a bailout, I have a very big problem with that. So that’s why I find it’s very interesting that you’ve seen such support in the U.S. this sort of policy from conservatives, which typically have a more libertarian bent and it’s basically socializing a lot of the industries as the U.S. Will Fed will become a creditor for a lot of different companies.
Julian Klymochko: Yeah, I think the issue is there is a lot of mixed feelings. I see a lot of anger from people, and so the government is in a really tricky spot here. Number one, exactly what is going on? Well, obviously, there is the coronavirus pandemic. And in order to protect society, protect largely elderly, the most vulnerable, the government had to basically shut down nearly every business. Right, and most businesses, if they are not up and running their costs, don’t necessarily go away. And so there’s this government mandated shutdown, and if that’s the case, it’s this government-mandated recession and if you are a business, then it makes sense to want compensation from the government because they did force this shutdown, so that’s one thing, and you can do it from that side. You know, its fine bailing out companies. It is not their fault. It is the government who is doing this.
We are all kind of getting through this together. And the government certainly should stimulate to get us through this sort of stopgap period until the Coronavirus sort of simmers down and we can get it under control, whether through social distancing measures such as that or we finally get effective treatments and vaccines. So that’s one thing but on the other hand, you have highly leveraged private equity companies, extremely wealthy, you know, private equity partnership. The guys who run these firms where they do leveraged buyouts. The resulting company takes on a significant amount of debt by a significant- we are talking about- six to seven times EBITDA. Such that unless everything goes perfectly smoothly. Those companies are at high risk of going bankrupt, and the reason that private equity companies put on vast amounts of debt leverage in their portfolio companies is to make themselves more money so you can view it out of the microscope or the viewpoint of greed such that they’re getting too greedy using too much debt, such that if there’s a rocky time period like right now, those companies immediately run into liquidity issues.
Right, and now they have to go hand in hand to the government. Oh, you know, we are in trouble. We can’t make it one month with no revenue. Bail us out, so I think there is a lot of negative sentiment from that perspective. It is basically backstopping companies that took way too much risk for investors that were too greedy. Because when you take on that much leverage, it’s basically a trade-off. You are taking on more risk to generate higher returns, and imagine if you are an investor. If you could lever up your own portfolio through your margin account and all of a sudden things go down and you start getting margin calls, you know, is the government going to be there to bail you out when you get a margin call? I don’t think so. So many people upset that, you know, these very wealthy private equity individuals and firms are getting bailed out here.
And then you look at the other side of the coin, which is the human impact. Clearly, if we look at the unemployment numbers, which are just absolutely dismal, U.S. came out with unemployment claims last week, 6.6 million in one week, which is just a massive record. Typically, it is a small fraction of that and that 6.6 million dollar.
Michael Kesslering: 16 million over three weeks, which is also insane.
Julian Klymochko: Yeah, 17 million since the coronavirus pandemic shut down vast swaths of the economy and then you look up in Canada. Canada posted record breaking 1 million jobs lost in March and an unemployment rate soared to seven point eight percent. And so you have this concern from society, from people saying, you know, is it really being allocated all these stimulus funds to the right people? But then the government needs to balance that timeliness. They can debate over this for months and months, because then people are suffering every single day. Wondering how they are going to make rent, how they are going to make their mortgage payment or, you know, buy food to feed their families.
And businesses are at the risk of going bankrupt. So they really need to get the stimulus done as quickly as possible and really didn’t have time to necessarily iron out all the details. So it is somewhat controversial, but ultimately a good thing. Great thing for businesses. Great thing for individuals and most importantly for at least what we are talking about here, which our markets certainly great for risk assets and we will leave it at that. Just massive stimulation going on from governments globally. The Fed’s 2.3 trillion stimulus package just the latest but this whole coronavirus pandemic has hit certain companies harder than others, one of which was WeWork, which we discussed last week on the podcast.
AirBnb IN TROUBLE AS IT WITHDRAW IPO AND COMPLETE A DISTRESSES FINANCING
Julian Klymochko: This week we are talking about AirBnb, which has been hit especially hard. They basically went from, you know, peak to Valley over the past three months. 2020 was supposed to be AirBnb year; it was going to be the hottest IPO of the year at a valuation of more than 50 billion dollars. But of course what the coronavirus, it’s suffered a dramatic setback that’s put their mere existence potentially in jeopardy. Like this virus completely messes up their entire business model, which relies on travel, which relies on people renting other people’s space to stay in. I am a pretty heavy user of it when I’m traveling. I really like it. I prefer it over a hotel most of the time but with no people traveling. With people, social distancing and staying at home.
This led to a dramatic decline. You know, I have heard upwards of 90 percent decline in revenue spiralling losses. They are expected to lose over $1 billion dollars in just the first six months of 2020, which has created liquidity issues. And by liquidity means they’re running out of money. So in order to address that liquidity problem, they tap private equity firm SilverLake and Sixth Street Partners for a rescue-financing package. This included a one billion dollar loan at a pretty serious rate of Libor plus 10 percent. What Libor is, it is basically a floating rate in which banks lend. They will lend to companies at a spread above Libor or if you are a good quality company. Typically, it is Libor plus 1 or 2 percent but AirBnb is getting live or plus 10 percent, which is a very, very steep and indicative of the dire straits that they were in but in addition to that one billion dollar loan, they had to offer these private equity firms additional equity warrant kicker’s. Struck at a fraction of its previous valuation, so these equity warrants, I believe, are issued at an 18 billion dollar strike price, so this is a pretty substantial discount to the proposed IPO, which is clearly off the table now. And that’s about half of their latest private funding valuation in 2017. So certainly, a highly distressed financing at AirBnb their bookings are down I think in China, up to ninety six percent in January.
And you see that come into North America, I believe their U.S. bookings are down over 80 percent. So certainly tough times for AirBnb. What are your thoughts on that company? Are they going to survive? What do you think the future holds for AirBnb?
Michael Kesslering: I mean, I do think that they will survive. I guess it is similar to the last question of who will be the owners in this situation.
Julian Klymochko: Investors support.
Michael Kesslering: Yeah, who will be the owners in this situation? So SilverLake, they are involved in this transaction providing that billion dollars of financing. You had mentioned the terms. Really, at a distressed financing level specifically with SilverLake. I just wanted to mention that with Cindy Sheehan, the author of Term Sheet by Fortune Magazine. As this week, if SilverLake is the Coronavirus era, Warren Buffett as in the great global financial crisis. Buffett did strike some very favourable deals with some of the banks for Prep’s and warrants, and so in this situation, Warren Buffett really has been quite, quite.
Julian Klymochko: Yeah, where has Warren been? Like everyone’s been expecting him to be making deals, doing deals, rescuing companies, landing that elephant that he’s been looking for, that massive acquisition that he’s been looking to do for the past 10 years. And what he’s got 120 billion cash or more. So where has he been? We have not seen anything from them except some stock sales, which really shocked investor.
Michael Kesslering: Yeah, sales. Yeah, from selling some of the airlines, his sales of Delta, where they have been talked about over the last week, which is, you know, not his typical move in the midst of a crisis, but. Yeah, so in terms of SilverLake, she pointed out how in addition to this deal with a distressed AirBnb, how they had come to the rescue for Twitter while they were fending off their activist investor, Elliott Management, I believe they came to a deal in early March. This billion dollar financing that they brought for Twitter enabled them to enact a $2 billion share repurchase program to appease Elliott. And then also in early March, during the midst of the crisis, they let funding round for Google’s self-driving car unit Waymo for over $2 billion dollars. And I will note that there is a little bit of Canadian flair in that deal as well with CPPIB, Canadian Pension Plan Investment Board, as well as Magnin International were involved in not financing. But really just an interesting situation where Silverlake, a private equity player, has made themselves involved in some of these distressed situations.
As well, I would like to compare this financing. So AirBnb financing and compared to Slack’s, now it is not a perfect comparable as one is public and one is private as in a private or public deal you do have for any convertible deal, a lot of the flow will be taken on by convertible arbitrages. But in this situation, it’s just a real tale of the sentiment between AirBnb and Slack which is one of the main companies that has been the beneficiary of the work from home investment trade. But in Slack situation, they issued seven hundred and fifty million dollars’ worth of convert’s in the last week. That will pay zero point five percent interest, compared to the over 10 percent interest rate that AirBnb will pay. And then will convert at a premium valuation as opposed to the AirBnb which I believe you had mentioned would strike $17 billion valuation compared to their most recent internal valuation of twenty six billion dollars at AirBnb. So just a tale of how the coronavirus pandemic has affected two different very high profile start-up companies.
Julian Klymochko: Certainly, and it is a good point you make about sentiment because what the past six months have shown, sentiment can absolutely turn on a dime. We go back to last summer WeWork was the talk of the town talking about 80 to 100 billion dollar IPO. As we know, that failed dramatically and now WeWork really on the ropes. Their bonds are trading at thirty-six cents on the dollar. There is a high probability that they go bankrupt and that equity is worth zero. Now you are saying something similar with AirBnb, talking about a 50 billion dollar valuation in its IPO. The talk of the town. Hottest IPO, of the year, to highly distressed financing with their existence and future and don’t as a going concern. So it’s really important, you know, if you’re reliant on capital markets to fund your business and then that really increases risks for investors, because if sentiment flips, then things can get very bad very quickly. And equity values can decline dramatically, so it’s great for profitable companies because they can make it through without relying on capital markets for additional financing. But when they are reliant, then a mistiming such as this. AirBnb just waited too long to go public and it costed them dearly. Had they gone public a bit earlier, they would have had significant amount of liquidity. No need to do a distressed financing, but unfortunately that did not happen. My thoughts? I think they will survive. The company indicated their capital cushion of about 4 billion. They do have investors willing to support them. Albeit at very, very high expected financing terms, pretty punitive terms there. However, once we get through Coronavirus, I believe they do have a valid business model. Not sure if the same thing can be said for WeWork, which we have talked about significantly.
JACK DORSEY PLEDGE $1 BILLION IN FIGHT FOR CORONAVIRUS CURE
Julian Klymochko: But another thing you discussed was what happened with Twitter. One thing that I wanted to mention is Twitter’s CEO. Yeah, for sure. We are a bit hard on his part time gig between Twitter and Square and with respect to the recent activist involvement by hedge fund Elliott Management at Twitter. However, what he did this week, really, really, we’ve got to give him kudos for what he did was he pledged 1 billion of his square stock that represents over a quarter of his net worth, about 28 percent of his net worth $1 billion. He pledged to help fund the Coronavirus relief effort so kudos to him. Massive, massive news, everyone is affected by this. And that capital can certainly fund a lot of research and development efforts into vaccines, treatments, medical equipment. This will definitely save a lot of lives, so my hat’s off to him there.
He indicated once this pandemic is resolved, which it will be, at some point in time, this money will go to focus on improving girl’s health and education. In addition to advancing universal basic income. In addition to that, I just wanted to give a shout out to other basically very successful entrepreneurs, wealthy individuals that have donated money to help solve this coronavirus pandemic. Jeff Bezos donated one hundred million to Feeding America. Michael and Susan Dell donated hundred million to global relief efforts, and then Bill and Melinda Gates Foundation pledged that similar amounts. They are really trying to develop a vaccine and addition to other treatment efforts. So certainly, people are stepping up to the plate here and Jack Dorsey doing it bigger than anyone, so hats off to him. Pretty fantastic news in my opinion.
Michael Kesslering: Yeah, so we were a little bit critical of Jack Dorsey a while back on the podcast and we were discussing Elliott Management’s activist campaign on Twitter where they were actually calling for him to be fired as CEO. And I also would say that I don’t find myself agreeing with Dorsey on a lot of his views necessarily, but in this situation, as you had mentioned, like this is an unambiguously good thing that he did. There is not many people so far that have been willing to stake a very large portion of their net worth, towards combating COVID- 19. In this instance, I believe it is about 28 percent of his net worth. You did mention a few others that have bit of stake, you know, multi-million in the hundreds of millions of dollars towards combating COVID-19, but you know, it really not at this scale and not at this portion of their net worth. You know, even if you or I were to stake a large portion of our net worth, it would not come nearly as much scale as Jack Dorsey. So really, hats off to him. This is just a really great move and something that, I believe you mentioned, he has done in the past as well. He has been quite charitable with the money that he has made as a very successful founder in the tech industry.
Julian Klymochko: Sorry, Jack, we love you, bro.
MARCH FACTOR PERFORMANCE
Julian Klymochko: So what happened in March? Crazy, crazy market environment. We had record VIX. North of eighty-five, had never even hit that in the great financial crisis 2008-2009.
So it hit eighty five on March 18th, and the VIX is the fear index. So really just indicative of the massive volatility. Stocks plummeting during the month, suffered one of the largest monthly losses on record on March 16th. The Dow Jones fell, nearly 13 percent, which makes it the largest drop of all time, aside from Black Monday, 1987. They are now calling that Black Thursday, March 16th, when the Dow dropped about 13 percent. So certainly, a very skittish environment, but what we are talking about here is multi-factor long, short investing. So we look at factors such as value, quality, price momentum, operating momentum and trend.
And when we talked about it and a long and short sense, you’re basically market neutral where you buy top decile stocks on that factor and then you short the bottom decile, i.e. the worst ranking stocks on that fact, and we saw some pretty interesting results. And multi-factor longsword investing, it held up quite well given just the crazy environments. All-things considered, multi-factor long short in the U.S., it is actually up 2.5 percent in March and down 3.2 percent in Canada. So up 2.5 percent in the U.S. last week on a North American basis, pretty balanced. And what we saw basically a continuation of the trend value just got absolutely crushed, especially in Canada. The long leg of the long, short value trade, by mid-March, Canadian value stocks were down nearly 50 percent. That is 5-0 percent, got absolutely smoked. While the most expensive, the most overvalued stocks were only down about fifteen but longsword value in Canada down 20 percent. Clearly the worst factor, not nearly as bad as in the U.S. down 5 percent.
Quality did poorly, but not as poorly as value. You look at the other side of the coin. Price momentum absolutely killed it where your longs dramatically outperformed your shorts by a double-digit percentage. Nearly 18 percent in Canada and twelve percent in the U.S. You had really good performance out of both operating momentum and trend as well.
So by and large, good performance from multi-factor long shorts, and an extremely tough month. Highly volatile month for long only investors, which really just shows you the strength of uncorrelated investment strategies, specifically including some shorts in your portfolio and having that market neutral bend can really bail you out during massive bear markets, which we just had in March. So certainly very interesting price action. Do you have any thoughts on what happened there?
Michael Kesslering: Yeah. No, not too many, not any distinct thoughts on my side. I guess just a question on the value factor over the past month. There is obviously was quite a big difference between how the value factor performed in the U.S. versus Canada. Do you have any idea why it would have been? You know, I guess the greater impact in Canada versus the U.S.
Julian Klymochko: Who knows? Perhaps in the Canadian markets there is more cheap energy stocks. If we go to the U.S. S&P 500 and relook at securities outside the S&P 500 for our multi-factor models. However, this is just indicative of the market composition of the US versus Canada. At one point, you know, Canada had north of 30 percent of the index, made up of energy names believe 25 to 30 percent. And the latest I’ve read, the S&P 500 had maybe 2 to 3 percent. So it’s a really big divergence in composition of the equities in each market. Historically, Canada more resource focused. U.S. more financials and technology focus. So perhaps that is it. I haven’t really drilled down into the specific sectors, but as we know, in March, energy getting absolutely destroyed, oil and gas stocks getting crushed after the massive drawdown and price war in the oil market, so that’s something to consider on that side of things there.
But other than that, that’s basically all I had to say about multi factor and market performance in March. We will wrap things up here. So thanks, everyone, for checking out this episode, The Absolute Return podcast, if you enjoyed it. Please check out more at absolutereturnpodcast.com and you can definitely follow us on Twitter. My handle is Julian Klymochko, K-L-Y-M-O-C-H-K-O. and Mike your Handle is?
Julian Klymochko: So we had a big week in the market last week. I think the S&P was up. What? Eleven percent? Basically one of the best weeks in a very, very long time, many decades. So hopefully for investors that can continue or certainly seeing things starting to normalize, the VIX has come down to about forty-five, which is still quite extreme. We view anything above 30 on the VIX as being an extreme reading historically in calm environments it is more around 15, so we will seek to see that further come down, more positive data coming out of the COVID-19 cases globally, specifically in the U.S. But until next week we wish you the best in your investing, trading, short selling, arbitraging and we’ll chat with you soon. Cheers.
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