Matt Levine is a Bloomberg Opinion columnist covering finance. He was an editor of Dealbreaker, an investment banker at Goldman Sachs, a mergers and acquisitions lawyer at Wachtell, Lipton, Rosen & Katz, and a clerk for the U.S. Court of Appeals for the 3rd Circuit. Read more opinion SHARE THIS ARTICLE Share Tweet Post Email

We’reDoingGreat

There is a standard story of WeWork, one that I frequently tell around here, that goes like this: Certain investors, particularly nontraditional venture investors like SoftBank Group Corp.’s Vision Fund, love to invest in fast-growing money-losing companies. Rapid customer growth is the main thing they want, and if that growth comes by losing money on every sale, well, that’s something to figure out later. The growth is the important thing; once you’ve achieved world domination by selling the product at a loss, you can find ways to make money from your large and locked-in customer base. Some big investors in private companies believe something like this, and they set the price in private markets, but the big investors in public companies don’t especially believe it, and they set the price in public markets. And when the fast-growing money bonfires try to go public, either it’s a disappointment (Uber), or it’s a disaster (WeWork). WeWork reached a $47 billion valuation on private-investor optimism, and then crashed into public-investor skepticism.

This weekend the Wall Street Journal had a big story on WeWork that suggests an alternate view of the company, one that goes something like this:

Private investors really like fast-growing companies that also make money, for fairly straightforward reasons; and WeWork was a fast-growing company that lost money; but WeWork just told investors that it made money.

I’m oversimplifying a little. You can’t just tell investors that you make money when you don’t. (I mean, you can, but it is frowned upon.) But you can get strangely close. “We made money last year” is either true or not. “We expect to make money next year” is a forward-looking statement and gives you some wiggle room. “We are in the process of making money this year” is … eh, look, I don’t recommend messing around with this, but WeWork sure did:

A presentation for prospective investors in fall 2014 projected the company would turn a $4.2 million operating profit for the year. When the year was through, just three months later, the company reported an operating loss of $88 million on $74 million of revenue, according to internal documents.

Hmm!

Mr. Neumann told The Wall Street Journal in 2015 that WeWork was profitable and it didn’t need additional funding before an IPO. It reported a $233 million loss for the year on $187 million in revenue.

In fact, WeWork has had only one profitable year in its history: 2012, when it generated about $1.7 million in net income, internal documents show.

Hmm! There is a funny graph of WeWork’s projected net income, at various points from 2015 through 2017, versus its actual realized net income; the short version is that the projections were positive and the realized numbers were negative. It happens; it’s hard to see years into the future. But WeWork’s vision seems to have been surprisingly cloudy, like, five minutes into the future.

Also this is funny:

WeWork’s business model was to lease long-term and charge higher rates to short-term small-business clients. That meant revenue relatively quickly exceeded the costs of operating its spaces. This is relatively common in real estate, but it looked extraordinary compared with software and hardware companies, which typically require years of investment.

I don’t quite know what to make of that? “Tech investors are not used to companies that make more money than they spend, so they were bewitched by WeWork, which … didn’t”?

It feels a little like the hero of this story is the U.S. public stock market. WeWork’s early investors and directors, for instance, hoped that the public market would save them from their own deferential instincts:

Several directors told others they took comfort knowing WeWork would soon need to go public because of its need for more cash to keep growing. The public markets, they told each other, would help serve as a check on Mr. Neumann.

And T. Rowe Price Group Inc., a big public mutual-fund company, invested at a $5 billion valuation in 2014 but was skeptical and disciplined where WeWork’s private investors were not:

“We saw the valuation rise and the corporate governance erode,” said Eric Veiel, co-head of global equity at T. Rowe Price. Amid concerns over issues like Mr. Neumann’s purchases of property he leased to WeWork, the mutual-fund manager made clear to Mr. Neumann, WeWork management and the board it had grown sour on the company, he said. “We sold as much as we possibly could,” he said, referring to two deals in 2017 and 2019, when SoftBank bought stock from existing investors.

But I should also acknowledge that the public-company disclosure regime comes out of this story looking pretty good. I, and others, have sometimes been critical of that regime for big tech-adjacent initial public offerings, including WeWork’s. Last month we talked about an investor presentation that WeWork prepared for potential private investors, and I mentioned how much better it was than WeWork’s IPO prospectus. The private deck was shorter, clearer, more direct, less flowery, less full of silly philosophical musings and more focused on the company’s actual operations. It reported numbers that did not comply with U.S. generally accepted accounting principles, but those were the numbers that WeWork actually used to manage its business, the numbers investors actually cared about.

And of course the numbers that investors really care about are forward-looking numbers, not how much the company made last year but how much it will make in three years. Potential private investors regularly get projections like that, but IPO prospectuses tend to stick to just the GAAP historical facts. (There are ways of conveying future expectations—through research analysts, etc.—but generally not, for legal-liability reasons, in the written prospectus available to all potential investors.) It is a strange sort of information gap: Public investors often don’t get the information that private investors consider most important. During the Uber IPO process, my colleagues on Bloomberg Opinion’s editorial board wrote:

Like many of the “unicorns” that have come to market in recent years — including Lyft, Snap and Pinterest — Uber is asking investors for an act of faith. Its traditionally required disclosures, such as three years of audited financial statements, mostly confirm billions of dollars in annual losses. Beyond that lies the great unknown. Uber’s prospectus offers only the vaguest picture of how it intends to achieve earnings that could justify a valuation of $90 billion or more. It says little about nascent businesses such as scooters and driverless cars that are supposed to drive its growth. … Companies going public should be expected to share the metrics they actually use to manage their businesses — including projected targets and strategies for mitigating risks. This needn’t be burdensome, because the companies typically provide such information to their private investors anyway.

And I basically agreed with them. There’s something weird about buying a company like Uber or WeWork that is entirely a bet on the future, whose historical financials have almost nothing to say about its expected value, with so few details of how the company’s management actually thinks about the future.

But here’s the counterargument! The counterargument is WeWork’s long history of providing worthless projections to private investors who then put in money at valuations that turned out to be excessive. The counterargument is that sometimes the company’s management has no idea how to think about the future, and you’ll do a better by extrapolating from past results (“hmm they lose money every year, maybe they’ll lose money next year”) than they will by writing down their aspirations (“we’ve lost money every year but a miracle is imminent”). Holding companies to the facts, rather than letting them spin the story they want to believe, is essential if they are selling stock not to sophisticated private investors but to the general public. But also sometimes the general public ends up looking more sophisticated than the private investors, because they don’t have dreamy stories to distract them from the facts.

Again, the standard story of WeWork is that private investors are okay with bearing years of losses to buy growth, and public investors aren’t. But a simpler, dumber, but plausibly correct story is that WeWork showed private investors documents with large positive numbers and so they invested, and then it showed public investors a document with large negative numbers and they did not.

Aramco

In a sense, Saudi Arabian Crown Prince Mohammed bin Salman failed in his goal to get large international institutional investors to buy shares of Saudi Aramco in its initial public offering this month. But in another sense no, it’s fine, the international institutional money is pouring in:

MSCI Inc., FTSE Russell and S&P Dow Jones Indices will begin to add Aramco to their benchmarks in an accelerated process due to the size of the offering, which could draw more than $1 billion to the Saudi stock market, according to analysts. The oil giant will also become part of the main Saudi gauge, the Tadawul All Share Index. … Buying from index-tracking funds could consolidate Aramco’s market value above $2 trillion, reached briefly last week and widely seen as desired by Crown Prince Mohammed bin Salman. International investors balked at the stock during the initial public offering. They pointed to, among other things, Aramco’s dividend yield, which now is just 3.75%, based on the $75 billion a year the company has promised to pay shareholders. That’s lower than peers such as Exxon Mobil Corp.’s 5% and Royal Dutch Shell Plc’s at 6.9%. Now, though, passive funds will buy the stock without taking price and fundamentals into consideration. Index inclusion also could encourage active stock pickers to consider the stock, since avoiding will be a bet against the benchmark.

I have talked a couple of times about my basic theory of Aramco’s limited local IPO. The theory is that if you go public and your stock trades at a $2 trillion valuation, you can sell more stock to big international investors at a $2 trillion valuation, using the simple argument “our stock is worth $2 trillion because it trades at $2 trillion.” Before you go public, investors will look at various valuation metrics to decide how much they want to pay for your stock, and if they come up with a $1.2 trillion valuation it’ll be hard to get them to pay $2 trillion. After you go public, investors will mostly look at the price, and if the price is $2 trillion they’ll start to think that’s fair.

This is not a very sophisticated theory or anything. Obviously lots of investors care about value, and if they think a company is worth $1.2 trillion and it trades at $2 trillion they just won’t buy it. And the ways that Aramco got to a $2 trillion valuation—basically, selling only a tiny float in the local market to investors who bought out of some combination of patriotism, government pressure, and special freebie bonus share deals—might lead international investors to discount that $2 trillion valuation. None of this is a secret, and you might expect sophisticated international investors to look through Aramco’s current trading price and stick to their own valuations.

But of course index investors won’t! Index investors don’t do valuations; they just buy whatever stocks are in the index, at whatever price they trade at. And then closet indexers buy the stock, and active-but-still-worried-about-the-index managers buy the stock, and before you know it everyone buys the stock and saying it’s not worth $2 trillion because of its dividend yield is a grumpy contrarian position.

By the way, all of this is … sort of an obvious trick? Like, go public with a limited float, put the stock in friendly hands, give investors incentives to buy and not sell, get a high price and then hand the stock off to index funds to consolidate that price and make a profit for the early investors. It is a trick that stock promoters know well, and one that index providers are on guard against; we talked recently about MSCI’s decision to exclude ArtGo Holdings Inc. from its indexes, after its price rose 3,800% to qualify for the index, because of “concerns about investability.”

But guarding against this—and accounting for “investability”—is subjective and complicated. MSCI’s Emerging Markets Index has a market capitalization of about $6.06 trillion, according to Bloomberg data. Aramco has a market capitalization of about $2 trillion; it would make up about a quarter of the index if you just added the whole thing. But that would of course be silly; only about 1.5% of Aramco actually trades, and even that number is artificially inflated:

Index compilers didn’t consider, or gave a reduced weight to, the tranche of shares that was sold to retail investors in the IPO, because individuals have the incentive to hold them for 180 days in order to get bonus shares. More passive inflows could arrive next year once the period expires and Aramco’s weight is adjusted up, analysts said. Arqaam and EFG-Hermes analysts expect Aramco’s weight within the MSCI Emerging Markets Index, the most popular gauge for investors looking at equities from developing nations, to be between 16 basis points to 17 basis points.

Aptitude

Here’s a profile of how great Jeffrey Gundlach is and how wonderful it is that he started DoubleLine Capital 10 years ago, which features this amazing explanation from Gundlach of the benefits of starting his own firm:

"It's the way we ran it for 20 years, as a firm within a firm. We started here, and then it was just a lot easier because when you're a firm within a firm, you not only have to manage people, you have to manage up, and I don't think I'm very good at managing up,” Gundlach told Yahoo Finance. Speaking about his early years in the industry, the investor described people as being “threatened by me when I used to report to people. They always seemed threatened by me because I think I had more aptitude than the people that I was working with or for,” he said. “And so they viewed me as a threat. And so we don't have that here. So everybody, I think, feels that it's a positive atmosphere,” Gundlach added.

I don’t think a lot of financial-industry job interviewers really ask people the clichéd “what is your biggest weakness” question anymore, but if anyone ever does ask you that in an interview, you’d better answer “well, I guess my biggest problem is that everyone I work with or for feels threatened by me because I have more aptitude than them.” That is now the canonical correct answer! Of course you won’t get the job, but that’s the point; if in fact your biggest problem is that you are better than everyone else and they know it, you’d better start your own firm.

Cold storage

For a while Bitcoin people got really into putting their Bitcoins in “cold storage” on hardware wallets disconnected from the internet, etching the private keys for the wallets on metal plates, and burying the plates in their backyards. Because Bitcoin was the future of money, see, and the future of money is burying metal in your backyard.

QuadrigaCX was a large Canadian Bitcoin exchange that had a lot of Bitcoins in cold storage, supposedly, and only its chief executive officer, Gerald Cotten, knew the private keys to get those Bitcoins (or knew where the metal plates with the keys were buried, etc.), and then he died suspiciously on his honeymoon in India and the exchange had to tell all of the investors, oops, sorry, all your Bitcoins are gone. The investors did not like this, not only because all their Bitcoins were gone but also because it turns out that Cotten was a serial operator of exit scams where he took people’s money and disappeared. So when he disappeared with Quadriga’s money, the investors were skeptical. (Of course they were not skeptical before he disappeared with everyone’s money, despite his long history of operating exit scams on the internet; cryptocurrency investors immediately become dogged, brilliant, clear-sighted forensic investigators right after their money is all stolen.)

And so they want to dig up his body, no problem, that’s totally normal:

In a letter to the RCMP, law firm Miller Thomson asked to have the body exhumed because of it’s clients’ large financial losses and uncertainty around Cotten’s death which “in our view, further highlight the need for certainty around the question to whether Mr. Cotten is in fact deceased.” “Representative Counsel respectfully requests that this process be completed by Spring of 2020, given decomposition concerns,” said Miller Thomson in the letter.

Also maybe the private keys are laser-etched in his tibia! It is all terrible on more levels than I can keep track of. When people tell you that cryptocurrency will enable smart contracts on the blockchain that supersede traditional court systems and automate trust, allowing frictionless commerce with no need for archaic subjective state justice systems, remember the time people asked the police to dig up a corpse to ask it who stole their Bitcoins!

Everything is securities fraud

We talked on Friday about a law review article by Brian Frye arguing that conceptual art is securities fraud. I (1) disagreed but (2) suggested that if he’s right maybe all of human society is also securities fraud, and that would be sort of comforting. It would just be a nice endpoint for Money Stuff; if we could prove that everything that anyone does is securities fraud then there’d be no need to, like, argue about the details of some credit-default-swap dispute or the tone of Elon Musk’s tweets. I did not mean any of this particularly seriously; have you noticed that it is mid-December? Anyway though here’s an important update from Brian Frye:

“I was so drunk when I wrote this paper,” said Frye. “It was one o’clock in the morning and I was three sheets to the wind.”

Fine, great.

Elsewhere here is “Matt Levine’s Insider Trading Game,” though I actually have nothing to do with it.

Things happen

Masayoshi Son’s Bankers Are Worried About Their Favorite Client. Rule Change Could Help Tech Firms Advance Into Banking. Fintech Lenders Tighten Standards as They Become More Like Banks. ESG Funds Draw SEC Scrutiny. PG&E Faces a Sprint to Fix Restructuring After Governor’s Rebuke. A Startup Fired Its CEO for Expensing $76,120 at Strip Clubs. JPMorgan’s Dimon issues racism warning to staff. Investors Fight Over Future of Saks Fifth Avenue. UBS’s Iqbal Khan to Restructure Unit Catering to Super Rich. UK dealmaker Robey tops £100m in pay since leaving Morgan Stanley. Top Turkey Bankers Say They Were Fired on Regulators’ Orders. Emmanuel Macron signals rethink on French-backed Africa currency. Man handed £193,000 in sort code error says he tried to give it back. Taylor Swift Calls Out Soros Family in Fight With Private Equity. Shift in Earth’s magnetic north throws navigators off course. Just Save Some Parties for January. The 100 Memes That Defined The 2010s. Why the Codpiece Remains One of Menswear’s Most Essential Accessories.

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