Tuesday, March 25, 2008
The Price Increase: a BS violation, but maybe with a purpose
by Ken HoughtonBailout Stock Offer Increase. And I think I have a theory that makes as much sense as any other.
As Carney notes, many of us who said nothing at the $2 level are screaming Bailout at the four-fold increase.* (Tom and cactus, as I noted yesterday, were ahead of the curve—I still think they were wrong, but let's go with prescient.) And, to give him credit, he also notes that this (1) may have been necessary for the market and (2) the shareholders could still make a lot of trouble (if they're asstupidstubborn as Yves, for one, believes they are).
Let us think for a minute about Black-Scholes. One of the key elements of the model is that square root of time thing: the longer you have to expiry, the higher the time value of the option.**
JPMC just went from having a lock-in until March of 2009 to needing things to be done on 8 April 2008. And they're paying more.
But, to reference another former firm,*** there was a period of time—around mid-2000, iirc—where Carly Fiorina (whose leadership and management skills are legendary) got it into her head to buy the consulting arm of PwC for about $18 billion. And negotiations went on and on. Others from the HP side talked it down to about $11 billion, and then HP decided that the employee turnover rate (the best of the Big Five, but still twice what HP was used to seeing) was too high. So the deal was called off.
For the six or seven months of that roundelay, though, the senior partners of PwC did virtually no Business Development. (Exceptions noted, but they were exceptions.) They were, as it were, counting their money.
So by the time the deal fell apart, the pipeline was dry. And along came a recession, and then 11 Sep 2001, and finally the business was sold to IBM in mid-to-late 2002 for, iirc, $3 billion.**** (HP went out and found a company with a low turnover ratio—Compaq—and the synergies created there made it a powerhouse that has only added to Ms. Fiorina's reputation.*****)
Now, I'm not saying that the time spent on the failed HP merger drained between 75 and 83% of the value of the company—but there's a reasonable argument that the market did, and it is certainly true that distracted partners don't generate the revenue stream that dedicated ones do.******
Now think about that in the context of an investment bank, where the cash flows are larger, quicker, and more fleeting. A business idea that is six months old still has value. A trading algorithm that gets delayed six months is likely to lead to losses.
So I suspect believe that Jamie Dimon has just played the last trump: "You want another $1 billion for the equity holders? All right, but you've got to finalize the agreement on this deal in the next two weeks, or I'm taking your building. And, by the way, if the deal fails, the market has already smelled blood twice. So Bring It On, if you want. But be careful what you wish for; you may get it."
Whether he finished with "Do you feel lucky, punk?" is left as an exercise to the reader. But with the value of the assets declining daily, Dimon probably realised that Black-Scholes wasn't the model to use for valuation.
It's still a bailout, but it appear to have a working logic to it.
*Yes, I said four- not five-, fold. Round figures, the swap went from 0.05 JPMC shares per BSC share to 0.21 shares, which is just over a four-fold increase (ca. 320%). The rest of the appreciation came from the rise in JPMC's stock.
**It's also one of the reasons no one would ever use the standard model to price a long-dated option. But that's a sidebar, not relevant to the example at hand.
***I've got a million of them. Well, sometimes it feels that way.
****None of these numbers or dates is necessarily accurate, but I believe they're close. You can look them up.
*****This you can definitely look up.
******It was legend at Bear that one of the then-current Compensation Committee members had maneuvered his nearest rival out of the job when the latter was tending to his cancer-stricken wife. But again I digress.
I've been trying to figure out the
As Carney notes, many of us who said nothing at the $2 level are screaming Bailout at the four-fold increase.* (Tom and cactus, as I noted yesterday, were ahead of the curve—I still think they were wrong, but let's go with prescient.) And, to give him credit, he also notes that this (1) may have been necessary for the market and (2) the shareholders could still make a lot of trouble (if they're as
Let us think for a minute about Black-Scholes. One of the key elements of the model is that square root of time thing: the longer you have to expiry, the higher the time value of the option.**
JPMC just went from having a lock-in until March of 2009 to needing things to be done on 8 April 2008. And they're paying more.
But, to reference another former firm,*** there was a period of time—around mid-2000, iirc—where Carly Fiorina (whose leadership and management skills are legendary) got it into her head to buy the consulting arm of PwC for about $18 billion. And negotiations went on and on. Others from the HP side talked it down to about $11 billion, and then HP decided that the employee turnover rate (the best of the Big Five, but still twice what HP was used to seeing) was too high. So the deal was called off.
For the six or seven months of that roundelay, though, the senior partners of PwC did virtually no Business Development. (Exceptions noted, but they were exceptions.) They were, as it were, counting their money.
So by the time the deal fell apart, the pipeline was dry. And along came a recession, and then 11 Sep 2001, and finally the business was sold to IBM in mid-to-late 2002 for, iirc, $3 billion.**** (HP went out and found a company with a low turnover ratio—Compaq—and the synergies created there made it a powerhouse that has only added to Ms. Fiorina's reputation.*****)
Now, I'm not saying that the time spent on the failed HP merger drained between 75 and 83% of the value of the company—but there's a reasonable argument that the market did, and it is certainly true that distracted partners don't generate the revenue stream that dedicated ones do.******
Now think about that in the context of an investment bank, where the cash flows are larger, quicker, and more fleeting. A business idea that is six months old still has value. A trading algorithm that gets delayed six months is likely to lead to losses.
So I suspect believe that Jamie Dimon has just played the last trump: "You want another $1 billion for the equity holders? All right, but you've got to finalize the agreement on this deal in the next two weeks, or I'm taking your building. And, by the way, if the deal fails, the market has already smelled blood twice. So Bring It On, if you want. But be careful what you wish for; you may get it."
Whether he finished with "Do you feel lucky, punk?" is left as an exercise to the reader. But with the value of the assets declining daily, Dimon probably realised that Black-Scholes wasn't the model to use for valuation.
It's still a bailout, but it appear to have a working logic to it.
*Yes, I said four- not five-, fold. Round figures, the swap went from 0.05 JPMC shares per BSC share to 0.21 shares, which is just over a four-fold increase (ca. 320%). The rest of the appreciation came from the rise in JPMC's stock.
**It's also one of the reasons no one would ever use the standard model to price a long-dated option. But that's a sidebar, not relevant to the example at hand.
***I've got a million of them. Well, sometimes it feels that way.
****None of these numbers or dates is necessarily accurate, but I believe they're close. You can look them up.
*****This you can definitely look up.
******It was legend at Bear that one of the then-current Compensation Committee members had maneuvered his nearest rival out of the job when the latter was tending to his cancer-stricken wife. But again I digress.
Labels: financetheory, High Finance, Moral Hazard, The Old Firm
