January 11, 2011

Facing the Book Facts

My flight today to Cincinnati through Atlanta froze in the blizzard of lost travel dreams. Which proved fortuitous, as I was able to skip Atlanta and flight straight to Cincinnati, saving me five hours. I love blizzards.

Speaking of sharing personal details, Facebook is the biggest entrepreneurial deal of the current day. It’s also a focal point for the widening divide between public markets and growth enterprises. Facebook may or may not go public. If it does, much of its prodigious progress will already have been funded, and the public markets will serve more as a wealth-transfer device than a capital-raising tool.

It’s a microcosm for investor relations. Speaking of speaking, I’m at the NIRI Tri-State Chapter tomorrow for what I have assured my hosts will be a riveting exploration of how to be cool in an IR seat heated to silliness by transient trading. Hope to see you locals there, by sled, snowmobile or telemark!

Anyway, according to the stock-market newsletter Crosscurrents, the average holding time for institutional positions is now 2.8 months. “The theory that buy-and-hold was the superior way to ensure gains over the long term, has been ditched completely in favor of technology,” writes Alan Newman, its author.

If buy-and-hold is out, whither the IPO? Not gone, but gone gargantuan. Small companies can’t count on sustained sellside support. There’s no money in it for bankers. Instead, bankers grow private companies, then cash out by IPO and leave behind not what Peter Lynch called a “ten bagger” but a massive trading vehicle with limited real growth. To wit, GM. Do you really think that’s going to produce…growth?

Translate that to the IR job and attracting institutional holders to established stocks. Institutions want cyclical value opportunities now. That’s basically what it means when big money looks for stocks yin when others yang. But now it’s about things out of step with the market, not with fundamentals. Well, how much time are you spending on tactical investor-relations with money that passes in and out? You should rotate how you target value, GARP and growth money according to short-term cycles. Grouse if you like. That’s the tape and you can’t fight it.

Back to the wealth-transfer idea, Goldman Sachs has taken heat for giving prized clients chances to participate in Facebook equity ahead of a possible flotation that will transfer wealth from the folks who buy the IPO to The Chosen who were in before.

Something similar happens daily in equity markets. Many broker-dealers, especially trading intermediaries, facilitate “risk transfer.” GETCO, an electronic trader, says it “helps transfer risk in the most efficient way possible.” GETCO uses its own capital in trading systems to be in the right place to profit by helping institutions move from premium-priced assets to discounted ones (for fleeting periods). Say, from a basket of equities to a conclave of currency futures.

Behind the scenes, brokers in the wholesale counterparty market are swapping interest in all kinds of things, including the rights to returns in equities. Remember, the currency and derivative markets are magnitudes larger than equities, which are but a means to an end. Your holders are doing this, probably the very ones that seem never to budge off core positions.

Do you see the theme? Facebook forms capital privately, then bankers transfer risk from limited upside for the privileged to somebody else, such as small investors who still think equity markets work as they always did.

Same with underwriters – the sellside. They’re brokering risk and wealth transfers and profiting in ways they never imagined when information, patience and relationships formed the foundation for capital instead of divergence and risk-transfer.

What do you do to make your fundamentals stand out in this environment? Part of me thinks banks would fall all over themselves to help public companies create, say, Exchange Traded Notes representing only interest in your profit outperformance versus a select set of peer companies. Or maybe you create a tracking stock with exactly the same features as your primary shares, so that you offer traders both arbitrage and risk-transfer yourself. Then every year, you retire them or dividend out the tracking units to shareholders. It’s sort of beating transient institutional money at its own game.

On the other hand, that’s absurd. But that’s what reality is for now – absurd. The only real way to solve this problem is to remove the incentive behind $4 trillion daily in currency arbitrage. Stop letting currencies float – at least the dollar – and fix values, so company shares have lasting, buy-and-hold substance. If we’re just transferring stuff, something is out of whack.

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