Fine, yes, Archegos
One thing about margin lending is that if you borrow money to buy stocks, and your stocks go up, you automatically deleverage. If you use $15 of your own money and borrow $85 from your broker to buy $100 worth of stock,[1] you have 85% leverage; if the stock then goes up to $200, you are down to 42.5% leverage. You still owe your broker $85, but now you have $200 worth of stock. If the stock then falls by 25% to $150, that’s fine: You are still in the black, and your broker still has ample security for its loan.
Money Stuff was off last week, and the big story of the week was Archegos Capital Management, the family office of former Tiger Asia manager Bill Hwang. The basic story of Archegos is that it extracted as much leverage as possible from a half dozen Wall Street banks to buy a concentrated portfolio of tech and media stocks (apparently partially hedged with short index positions[2]), and those stocks went up a lot, before going down a lot. One big position, for instance, was in ViacomCBS Inc., which was at $12.43 a year ago and got as high as $100.34 on March 22. Baidu Inc. went from $97.20 a year ago to $339.91 this February. Bloomberg reported last week that Archegos started with $200 million of assets in 2013 and peaked at almost $20 billion a couple of weeks ago, and that “much of those riches accrued in the past 12 to 24 months alone.” Which makes sense. If you put up $1 billion of your own money to buy $7 billion of stocks, and those stocks quadruple in a year, now you have $21 billion of your own money.
The incredible thing about Bill Hwang is that he made enormous levered bets on risky stocks, and those bets worked out perfectly and made him immensely wealthy in the course of a year or two, and he seems to have plowed every cent of it back into increasing those levered bets. So Viacom fell from $100.34 at its peak on Monday, March 22, to $48.23 by that Friday, March 26. That’s still higher than it was trading for most of January. If Hwang was 85% levered in January, and then left those positions alone, he would still be about 85% levered now — meaning that he would not have gotten any margin calls, his prime brokers wouldn’t have had to sell any stock, he’d still be worth many billions of dollars and his brokers would still be clipping fat fees without any losses.
But that’s evidently not what happened. Instead Hwang kept borrowing more; indeed, it seems that the reason his stocks went up so much in recent months is that he kept buying all of them. Here’s a nice detail from Bloomberg’s reporting:
Underscoring the chaos of an escalating situation, representatives from Credit Suisse Group AG floated a suggestion as they met last week to confront the reality of such an exceptional margin call and consider ways to mitigate the damage: Maybe wait to see if his stocks recover? Viacom, some noted, seemed artificially low after its run-up past $100 just two days earlier.
Yet it was Hwang’s own orders that had helped make Viacom the year’s best performer in the S&P 500, forcing benchmark-tracking investors and exchange-traded funds to buy as well. Without him creating that momentum, Viacom and his other positions had little hope of rebounding.
There is a simple schematic trade here:
- Start with a lot of money.
- Borrow a lot more money.
- Use all that money to buy a ton of a small handful of stocks, cornering the market in those stocks and pushing up their prices.
- As their prices go up, you have more equity — your positions automatically deleverage.
- You use that equity to borrow even more money and plow it back into those stocks, pushing them up more.
- Repeat forever?
A couple of points about this trade. One is, for Archegos, it can’t really go on forever, can it? You are operating with no margin for error; every time your stocks go up, you borrow more money to increase your bets. If your stocks ever go down, you lose it all.
And they will go down eventually. For one thing, the odds are that something will go wrong, that one of your companies will have disappointing earnings news. But also, if you pick a handful of companies and push all their stocks up a lot, eventually one of them is going to take advantage of its new high stock price and issue stock, as Viacom did last week. A big stock issuance adds supply and tends to push down the stock price; if you are running this strategy, you will need to buy more stock to keep up. But if you’ve already borrowed every penny you can get, how can you buy more stock? That actually seems to have been part of Hwang’s problem, the New York Times reported:
On Monday, March 22, ViacomCBS announced plans to sell new shares to the public, a deal it hoped would generate $3 billion in new cash to fund its strategic plans. Morgan Stanley was running the deal. As bankers canvassed the investor community, they were counting on Mr. Hwang to be the anchor investor who would buy at least $300 million of the shares, four people involved with the offering said.
But sometime between the deal’s announcement and its completion that Wednesday morning, Mr. Hwang changed plans. The reasons aren’t entirely clear, but RLX, the Chinese e-cigarette company, and GSX, the education company, had both spiraled in Asian markets around the same time. His decision caused the ViacomCBS fund-raising effort to end with $2.65 billion in new capital, significantly short of the original target.
ViacomCBS executives hadn’t known of Mr. Hwang’s enormous influence on the company’s share price, nor that he had canceled plans to invest in the share offering, until after it was completed, two people close to ViacomCBS said. They were frustrated to hear of it, the people said. At the same time, investors who had received larger-than-expected stakes in the new share offering and had seen it fall short, were selling the stock, driving its price down even further.
“The reasons aren’t entirely clear,” but the implication seems to be that Hwang — with a $20 billion net worth and perhaps $100 billion of gross positions — couldn’t find $300 million to put into the Viacom offering.[3] Everything he had was mortgaged to the hilt; there was just no spare cash lying around. “Archegos shocked its lenders when it told them the size of its portfolio and how little cash it was holding,” reported the Wall Street Journal.
Another point about this trade is that it has some obvious risks for the banks. If you are lending Archegos 85% of the value of its stocks — or more, I’ve seen reports of 8-to-1 and even 20-to-1 leverage — then if the stocks go down by more than 15% you lose money, and if the prices of the stocks have been inflated and supported by Archegos’s own buying then, yes, when it all ends, they’re going to go down by more than 15%. And so Bloomberg News reports that “banks roiled by the Archegos Capital fallout may see total losses in the range of $5 billion to $10 billion, according to JPMorgan.” “Credit Suisse Group AG leaders are discussing replacing chief risk officer Lara Warner while sparing Chief Executive Officer Thomas Gottstein as they tally losses that could reach into the billions from the collapse of Archegos Capital Management,” Bloomberg News also reports. “‘It’s pretty hard for me to defend why we loaned him so much,’ said an executive at a bank with billions of dollars of exposure to Archegos” to the Financial Times.
One possibility here is that the banks did not entirely understand what was going on. They knew their own trades with Archegos but — reasonably! — they did not know what Archegos was doing with other banks; they knew that Archegos was a big client but not just how big it was, and how concentrated it was in a small handful of stocks:
Archegos’s lenders say they were unaware of the extent of trades he was making with other banks, information that would have encouraged them to curb their lending. Banks can ask clients for information on their loans from other banks but clients don’t necessarily have to disclose it or their positions.
But one thing I want to say about the banks is that if you were one of Hwang’s prime brokers and you had perfect information — about how big he was and how concentrated, about how many banks were financing him, about his effect on stock prices, about Viacom’s stock offering, etc. — you might still rationally do this trade, if you were confident you could get out first. The basic dynamic of Archegos’s margin liquidation is that Goldman Sachs Group Inc. and Morgan Stanley blew out Hwang’s position in a series of big block trades on Friday, March 26. Those trades got a lot of attention, spooked the market, brought down the prices of Archegos’s holdings, put pressure on its other banks, and ultimately led everyone to blow Archegos out. But Goldman and perhaps Morgan Stanley were fine. The blocks were done at discounted prices, but prices that seem to have been above (or at least near) the amounts that Goldman and Morgan Stanley had advanced to Archegos. Goldman has said that the Archegos unwind “will likely have an immaterial impact on its financial results.”[4]
The other banks sold later and got worse prices. Part of their problem seems to be that they were too nice and tried to cooperate with each other. Bloomberg reports:
Emissaries from several of the world’s biggest prime brokerages tried to head off the chaos by holding a call with Hwang before the drama spilled into public view Friday morning. The idea, pushed by Credit Suisse, was to reach some sort of temporary standstill to figure out how to untie positions without sparking panic, the people said.
But any agreement was elusive, and by Thursday night, some banks had shot off notices of default to Archegos to seize collateral and potentially shop it to buyers to contain the banks’ potential losses, the people said. Yet even then, it wasn’t clear when terms with Archegos would allow sales to proceed, one of the people said.
Soon came the finger-pointing over who was breaking ranks, the people said. Some emerged from the talks suspicious that Credit Suisse wasn’t fully committing to freezing sales. By early Friday, rival banks were taking umbrage after hearing that Goldman planned to sell some positions, ostensibly to assist Archegos. Morgan Stanley began drawing public attention with block trades.
As is so often — not always! — the case, the market rewarded absolute unsentimental ruthlessness here. A bunch of prime brokers got in a room to give speeches about working together and preserving value and not artificially depressing prices, and the Goldman representative was texting colleagues under the table “SELL EVERYTHING!” Goldman was right.
A couple more points. One is that this whole situation is extra awkward for the banks — again, Goldman and Morgan Stanley — that both (1) were Archegos prime brokers and (2) led the ViacomCBS stock sale. CNBC reports:
While certain bankers at Morgan Stanley and Goldman Sachs were pitching that deal to investors, some of their peers in the prime brokerage division were growing increasingly concerned about the risk profile of one of their clients, a family office called Archegos, which had large, leveraged exposure to ViacomCBS.
Following a 23% decline by ViacomCBS amid the secondary offering, Goldman Sachs, Morgan Stanley and a slew of other banks across Wall Street, triggered a margin call on Archegos.
This prompted the two giant investment banks to seize Archegos’ assets, including billions of dollars’ worth of ViacomCBS stock, and sell it off through heavily discounted block trades. The move created significant pressure on the B shares of ViacomCBS, which plummeted 27% on Friday and another 7% the following Monday.
Still, the timing of the events is raising questions over who at the firms knew what and when, amid the demise of Archegos and the collateral damage in several stocks, including ViacomCBS.
Yeah if I were ViacomCBS I would not be thrilled about that service.
Also here is a funny Financial Times story about how this has been bad for the reputations of Archegos’s prime brokers:
The head of one London-based hedge fund said the firm had “initiated an internal process” to evaluate its prime broking relationships in the wake of the Archegos debacle.
The top concern was reputation, particularly whether their clients believed they were “associated with the bad people” in the sector, the person said.
Another London-based fund said that, in the wake of the scandal, it had been receiving questions from investors about which banks it was exposed to.
“I’d not be very comfortable if we had balances” at one of the banks caught up in the scandal, said the head of a large Europe-based hedge fund firm.
I don’t get it? Intuitively you should want your prime brokers to be reckless and incompetent; it means they’ll probably give you more leverage on more generous terms.[5] I suppose the concern is that the prime brokers who got burned here will be more cautious in the future:
“Prime brokerage looks a lot riskier today than two weeks ago,” said Andrew Beer, managing member at fund firm Dynamic Beta Investments, who added he expected banks to cull riskier clients.
“Every bank risk manager will be in the hot seat to prove that outstanding lines and swaps to hedge funds and family offices are prudent and sufficiently collateralised.”
One last point is that Archegos did not do these trades by buying stock for its own account and borrowing from prime brokers to fund it. Instead, Archegos had its prime brokers buy the stock, and then bought it from them “on swap”: The banks wrote total return swaps giving Archegos the economic effect of owning the stock (but not legal ownership); the banks owned the stock themselves as a hedge for their swaps. These are economically equivalent transactions, and the banks understand that; it’s not like Archegos was somehow able to sneak more leverage past the banks’ risk managers by doing swaps instead of margin loans.[6]
But the main effect of doing it all on swap is that, in public filings and Bloomberg HDS screens, Archegos and Hwang did not show up as major owners of any company’s stock. This did allow Archegos to stay under the radar. I am not sure how much that matters. It matters to the extent that some banks might have given Archegos less leverage if they had known the size of his positions with other banks; if they had known how concentrated he was they might have been more careful.
But I suspect it mostly matters because it makes the story more exciting. This is not a story of a big famous hedge fund getting blown out of its giant positions. It’s a story of a big totally unknown hedge fund (fine, family office) getting blown out of its giant positions. You got the pleasure of discovering that Bill Hwang exists, and “was worth more than well-known industry figures like Ray Dalio, Steve Cohen and David Tepper,” at the exact moment you got the further excitement of learning that he lost all of it on wild levered bets. Because he did everything on swap, as far as most people are concerned Bill Hwang went from nothing to $20 billion and back to nothing in a single news cycle.
Obviously GameStop
GameStop Corp. (NYSE: GME) (“GameStop” or the “Company”) today announced that it has filed a prospectus supplement with the U.S. Securities and Exchange Commission (“SEC”), under which it may offer and sell up to a maximum of 3,500,000 shares of its common stock (the “Common Stock”) from time to time through an “at-the-market” equity offering program (the “ATM Offering”). The Company intends to use the net proceeds from any sales of its Common Stock under the ATM Offering to further accelerate its transformation as well as for general corporate purposes and further strengthening its balance sheet. The timing and amount of any sales will be determined by a variety of factors considered by the Company.
GameStop closed at $191.45 on Thursday; today it was trading at about $183 at 11 a.m. It was trading in the $40s as recently as February, in the teens as recently as January, in the $4s as recently as August. Since then a miracle has occurred? Since January, millions of retail traders have discovered GameStop and decided that they love its stock. I personally have been saying, since January, that if you are a struggling mall-based retailer of video games, and people are desperate to buy your stock at any price, you should sell it to them.
Now GameStop will. It will sell up to 3.5 million shares, which at Thursday’s closing price would raise about $670 million. (Presumably the stock will go down as GameStop sells, but you never know.) You can accelerate a lot of transformation for $670 million. With $670 million you could, I don’t know, buy a whole company in a different line of business? Acquire a game studio, close down all the stores in malls, boom, pivot by merger.
One thing that you could buy for $670 million is all of GameStop as of October 2020. I mean, you can’t now; now GameStop’s market capitalization is about $13 billion. In October 2020 it was under $670 million. Something has changed in its business since then — it has had a lot of boardroom and executive turnover and committed to a new goal of being more online — but that has not exactly been reflected in, say, better-than-expected earnings, or a new dominance in online game retail, or any specific public plans to become more online. Last year GameStop was a declining mall-based video-game retailer in a world in which games are increasingly downloaded directly from online platforms; now GameStop has basically the same business, but a whole new swagger and optimism in the stock market. I guess that latter part is worth $12 billion? I understand nothing.
Often around here I find myself defending stock buybacks. Often there are companies that generate income now but are in long-term decline. Cash comes in; what should they do with it? Investing it in their declining business seems wasteful. Investing it in some untested effort to pivot into a new futuristic business is risky; why would the executives of this old-timey company have the expertise to build the business of the future? Giving it back to shareholders, so the shareholders can invest it in whatever new business they want, seems like the rational, conservative way to go.
In the abstract I would have said that a mall-based video-game retailer would be a good candidate for, you know, managed decline. Collect money selling video games, send it back to shareholders, wait for native downloading platforms to become 100% of the games business, and when that happens quietly close up shop, secure in the knowledge that you extracted as much money as possible from your obsolescent business model and gave it to your shareholders.
But financial capitalism is much stranger than I would have expected. Instead of activist shareholders coming to GameStop and saying “Look, this business is doomed; you need to shrink the business and cash us out,” shareholders came to GameStop and said “Whee, diamond hands, rocket rocket rocket, take all our money.” GameStop’s shareholders said, in effect: “You are uniquely well suited to pivot to online retail and to become the future of gaming; in fact you are so well suited to do that that we’re going to value you as though you had already completely succeeded in doing that; now go get ‘em tiger.” What could GameStop do? The market has sent it an incredibly strong, incredibly weird signal; the market has told GameStop that it must transform into an online retailer, and that it has no chance of failing. Now the market will gleefully hand over some money so GameStop can make that come true. Seems like a lot of pressure, honestly, but also a lot of money.
Anyway here is the prospectus; it contains the risk factors (the stock is volatile for no reason, there is a short squeeze, people say all sorts of stuff on Reddit, etc.) that you’d expect from something like this, and that we’ve discussed previously. GameStop also pre-released sales results for the first nine weeks of this quarter. Obviously nobody buying the stock cares about any of this stuff, but just as obviously the Securities and Exchange Commission is going to be looking closely at this offering, so GameStop’s lawyers are being careful.
No comments:
Post a Comment