Waymo Coming?

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Alphabet’s earnings press release didn’t talk about it. Alphabet CFO, Ms. Porat, did say that revenues increased 22% from the prior quarter, making it a “terrific start to 2017”. You’ll need to wait until Alphabet releases its next quarterly 10-Q to find out about the Waymo v. Uber lawsuit.

Filed in February 2017, Waymo v. Uber avoided disclosure in Alphabet’s last filing for the quarter ended December 31, 2016. What’s known about the case has come mostly from court filings, but we have not heard much official from Alphabet. That should end when Alphabet files its 10-Q for first quarter of 2017.

Legal proceeding can be boring, but when money is at stake, then the bottom line can be impacted. Alphabet recently escaped paying billions in damages to Oracle in another lawsuit over intellectual property. Waymo v. Uber should prove that tech companies not only fight in the marketplace, but also in the courtroom.

Uber is Greek

Uber recently has had more drama than a Greek play. And with a $70 billion valuation, Uber has also become a Greek God, holding the aspirations of many: venture capitalists, angels, sovereign funds, and others. Many still question the valuation of Uber’s asset-like, toll-taking business model, but there’s at least one solid fact.

Last year, Uber did something right by leaving the money losing Chinese market. As part of its deal to exit China, Uber swapped its China operations for a piece of its competitor, Didi Chuxing. Uber’s eighteen percent of Didi has two benefits. First, if Uber loses to Didi it’s still a win for investors as the value of Uber increases. Secondly, the Didi investment explains a small part of Uber’s $70 billion valuation.

 

 

Airbnb Following Uber

China’s sovereign wealth fund, China Investment Corporation (CIC), participated on Airbnb’s most recent funding round. 

It’s a move reminiscent of the Saudi Arabia Public Investment Fund’s $3.5 billion investment in Uber last year. Beyond financial gain for the Kingdom, Saudi Arabia also gets mobility solutions and employment opportunities for its citizens. Uber, on the other side, is able to expand into another part of the world, especially an emerging one.

Airbnb acknowledged China’s growth potential by establishing working relationships with China Broadband Capital and Sequoia China in 2015. Since then, Airbnb set up its China subsidiary and last fall, was reportedly in discussions to purchase Airbnb clone, Xiaozhu. Now with the CIC investment, Airbnb could be getting help from the Chinese government, besides just funding.

Kicking Otto Tires

Did Uber really kick Otto’s tires, given the recent Waymo lawsuit?

Alphabet’s self-driving unit, alleges, among many things, that its lidar designs were taken by Otto co-founder, Anthony Levandowski. Formed in January 2016, Otto was eventually purchased for $680 million just three months later by Uber.

Given the outcome of Waymo’s lawsuit, there is a possible due diligence failure by Uber. Due diligence has many definitions, but the short of it is knowing what you are buying. A due diligence failure definitely happened in hedge funds with Bernie Madoff and may be in venture capital with Theranos.

With talent scarce, traditional and tech companies compete for people with autonomous car experience and knowledge. So there is more acquisitions of startups and structures allowing for the licensing technology as seen with Ford’s majority purchase of Argo AI.  

Now with the increase in investments and Waymo’s lawsuit, there could be more thorough due diligence by parties transacting in the autonomous car arena.

 

TPG + CAA = Tech

Reading through the book, Powerhouse: The Untold Story of Hollywood’s Creative Artists Agency, provides one with insights into the potential public offering of AirBnb and Uber. Covering the short life of Creative Artist Agency, Powerhouse tells its story with interviews of stars, agents, producers, and private equity co-founders.

TPG is the private equity firm which invested in CAA over the past ten years and that story is told in the later chapter of the book. Author, Jim Miller, interviews TPG co-founders David Bonderman and Jim Coulter who share their views on different topics, including going public.

Jim Coulter:

“There are two misconceptions I often run into regarding private equity. The first is when we go into an investment, we have a plan for how long it will be before we exit. That’s absolutely not true. The second misconception is we have a three-to five-year holding period, which is definitely not the case.”

David Bonderman:

“The advantages of being public are that is can be easier to raise capital; it gives you a currency if you wish to make acquisitions or provide incentives for people you want to come join your firm. It also interferes with your privacy, so there are plusses and minuses.”

David Bonderman and Jim Coulter words should carry authority and importance in the world of tech. TPG is part of the new money following into tech in the form of growth capital. Unicorn and AirBnB were recipients of money from TPG’s Growth Fund II. In 2015, TPG closed Growth Fund III with $3 billion.

 

Uber NO, But You Can Short SF

 

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Steve Levine

Uber is high, besides being bigger. With its current $62 billion valuation, people are wondering how to profit if things go the other way for Uber.

In fact author, journalist, instructor, jack of all trades, and not master of finance, Quartz’s Steve Levine recently declared:

Investors have placed a one-way bet on Uber—which made us want to find a way to short it

After an epic post, Mr. Levine finally concludes shorting Uber is impossible. Along the way he consults many academics, but doesn’t bother interviewing famous Enron short-seller, Jim Chanos of Kynikos.

Yes, Mr. Levine you can not short Uber or other unicorns, but why bother? If you are interested in making money, why not just short San Francisco.

Shorting

According to Mr. Levine , you need the following for the successful short trade:

We start with the two simple rules governing the successful short: You need superior information, and a high trading volume so you can sell your position fast. 

This is not exactly true. First, you need “superior information” for any trade, long or short. Secondly, you don’t need to sell in high trading volume to be successful.  To profit from the short trade you need to sell the stock at a high price and then buy back the stock at a lower price.

To sell first, you first need stock to sell. Normally in the public markets, the short-seller first borrows the stock that is then sold at the high price. When the stock price drops, then the short-seller buys back and then returns the stock to the lender.

It’s really the mechanics of the short trade, which makes shorting Uber or unicorn nearly impossible. To execute the trade you first need someone to lend you the shares and secondly you need a liquid market to sell and then buy back the stock.

Startups and later stage companies occupy the world of private equity, which means not public markets. In private markets there is not much liquidity nor information. It for these reasons that private equity is favored by larger players, such as the Yale Endowment.

Shorting Uber is nearly impossible, because you first need actual Uber shares to sell. Uber and other unicorns make it hard for anyone to sell their shares, let alone lend them to someone else. So shorting actual Uber stock is nearly impossible, based upon the short trade itself.

Futures

After much rambling, Mr. Levine then decides:

I decided to look at CDS as a possible path to shorting Uber.

CDS stands for Credit Default Swap. Credit default swaps works similar to car insurance. One person pays a premium to another party. In exchange, the other party agrees to give you the full value of your car when damaged.

Instead of damaged cars, the credit default swaps are insurance on bad debt. If a bonds defaults, then you will receive the full principal amount of the bond. Credit default swaps are not even a direct short. Instead, the CDS was used as a bet on a company’s improving or decreasing credit risk.

If you really want to short Uber debt, you would use a total return swap. Why? Because derivatives are an alternative to shorting the actual security such as stock or bonds. Derivatives are just financial contracts where two parties exchange promises, like the futures contract.

In a futures contract, one party promises to deliver goods at future date and the other party promises to pay an agreed upon price. Farmers commonly use futures contracts to lock in the price for their harvests. The time between planting and harvest is long and prices can change. Farmers can shift the price risk to someone else, the speculator. Here the farmer is short and the speculator would be long.

In the spring, the farmer would sell futures contract that guarantee the price of the harvest. The contracts sold call for the delivery of corn on a date in the fall. On that future date, the speculator will pay the agreed upon price of $100 per bushel. If the price of corn declines, then the farmers wins. The speculator hopes the price will be higher, because after receiving the corn, the speculator can sell the corn for more than $100 per bushel.

Equity Index Futures

In 1970’s, there began many new futures contracts, not for physical assets, but financial ones, such as stocks. Instead of delivering corn, the seller of the futures contract agrees to deliver a basket of stocks. The speculator still agrees to pay an agreed upon price.

Futures contracts on baskets of stock are called equity index futures. They have the advantage of allowing an investor to short a basket of stocks. If you think the S & P 500 Index will decrease, you would sell an equity index future. But instead of delivering the actual stock, you can deliver the cash value of the stock basket.

Assume, you think the S & P 500 index is too high at 2200. You decide to short the index by selling one futures contract (E-mini). The contract you sell will expire in February 2017. At that time, the buyer of the contract has agreed to pay you the current value of the index, or $110,000.

In February 2017, the S & P 500 Index does decline and the cash value of the stock you must deliver is $75,000. Instead of delivering the basket of stock, you pay $75,000 and the other party pays you $110,000. The net amount of $35,000 is your profit from shorting the S & P 500 Index.

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Real Estate Futures

Mr. Levine concludes he can’t short Uber, but along the way, he stumbles upon this potential trade:

You also might create a derivative that shorts the San Francisco real estate market, which in the past has boomed during big IPOs.

Someone did “create” such a derivative and it was done in part by Nobel Prize winner, Robert Shiller. In 2007 futures contracts started trading at the CME allowing anyone to be either long or short real estate, or this case San Francisco.

The futures contracts are based upon the Case-Shiller Home Price Index. Futures buyers and sellers are betting solely on the dollar value of an index. The index is the price level residential real estate. For San Francisco, the index measures the prices of single family residential homes in the counties of Alameda, Contra, Marin, San Mateo, and San Francisco.

In the graph below shows the beginning of the index in 2006 at the level of 217.52. As the economy imploded in 2008, the index reached a low of 117.17. At May 2016, the index level was 227.54. Each futures contract is worth $250 times the index level. So for May 2016, the San Francisco Real Estate contract is worth $56,885.

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San Francisco Case-Shiller Price Index, 2006-2016

If you want to short San Francisco, you would sell one futures contract for $56,885. Let us assume, the contract will expire in December 2017. Between then and now, the bubble bursts, money stops flowing into San Francisco, and people decide to leave, pushing down home prices.

In December 2017, the index level is no longer 217.52, but closer to 117.17 as in 2008. Now the value of the contract is $29,293. On expiration date of the contract, you would deliver the dollar value of the index or $29,293 and be paid the agreed upon amount of $56,885. The profit from shorting San Francisco is $27,592.

Disclaimer

This post is for educational purposes only and should not be used for investment purposes. Short-selling should only done by experts and certainly not by journalists or in their ramblings.

 

New Score: Uber Won and Saudis Lost

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Uber recently received more money. This time, the amount of $3 billion was received from the Saudi Public Investment Fund or PIF. Reaction was varied and mixed due to the source of the money (Saudi) and use of the money (China) by Uber. Overlooked in the discussion were the poor people of Saudi Arabia. It’s the Saudi citizens who are expected to benefit from the performance of the Fund.

Sovereign wealth funds are investments established and run by Governments. In the Gulf, Qatar, Kuwait and Abu Dhabi set up such funds with oil and natural gas revenue.  One the earliest and and largest is the Abu Dhabi Investment Authority which manages nearly $800 billion. Now the Saudi Royal Family plans to increase its sovereign wealth fund, the PIF, with an IPO of Saudi Aramco.

But having lots of money, doesn’t necessarily make you the smart money. Case and point here is the King Abdullah Financial District (KAFD) on the fringes of Riyadh. In better times, the idea was to create a financial international center to rival Dubai. After being completed or near completion, the project is now in need of tenants. When the project opened back in 2013, the vacancy rate was 90%. That’s probably worse than the vacancy rate for Hotels on Baltic Avenue.

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And now the Saudi Public Investment Fund is the proud owner of at least part of the KAFD. Sovereign wealth funds are active investors in real estate due the steady rents and opportunity for appreciation. Unlike people, sovereign wealth funds have an unlimited life. People need to save for retirement and some day the money is needed back. Sovereign wealth funds can invest for longer periods of time. The Saudi Public Investment Fund will need to wait a long, long time before its sees a return on its money from the KFAD.

In the investment realm, you judge money managers by alpha and beta returns. Beta returns are earned by riding the wave, being on the bandwagon, or following the herd. Here the money manager doesn’t need to have any special knowledge, other than know the direction of the market.  Alpha returns are those generated by people with skill, knowledge, or insight about a market. Alpha returns in the venture space could be those earned by early Facebook investors, such as the near legendary, Peter Thiel and the Russian, Yuri Milner.

Beta returns are average and alpha returns are above average. For Uber, the alpha investors (Chris Sacca) are those who  recognize the immense value to be created by Travis Kalanick, Garrett Camp, and the rest of the management team. Beta investors are those who are along for the ride. The returns of the later, beta investors depends on the price paid for their Uber stock. If the price is near the top value for Uber, the of chance of loss is greater.

In this situation, the later, beta investors now include the Saudi people.

 

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