July 21, 2023 | Peel #505

In this issue of the Peel:

• Blackstone makes history as the first asset management firm to reach $1 trillion in assets under management.
• The newest jobs report released by the US Department of Labor showed decreasing jobless claims and a strong workforce.
• Netflix’s password-sharing crackdown isn’t working quite yet. Although the company added 6mn new subscribers, the stock fell on a poor revenue forecast.

Market Snapshot

Happy Friday, apes.

Do you want the good news or the bad news first? I’ll pick.

The good: It’s Friday, and you’re almost at the end of the tunnel!

The bad: Markets took a nosedive, especially the Nasdaq, which lost all of its gains for the week in one day.

Disappointing tech earnings were the culprit. Netflix had its worst day of the year on shrinking revenue, and Tesla took a hit after Musk scared investors away with his $1bn “Dojo” supercomputer investment.

On the macro front, there were talks of a worsening conflict in Ukraine, more economic pain in China, and real estate losses. This made for a dark day in the markets but don’t let it put a hamper on your weekend plans!

Let’s get into it.

On Cycle is Here Early (Again)

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• Learn from experts at top PE megafunds and UMMs
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Don’t miss this opportunity to invest in your career and achieve your PE goals.

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Banana Bits

• David Rockefeller’s former NY mansion is going for $57mn. Maybe you can throw your hat in the ring after next year’s bonus cycle.
• Atlanta Braves fans can now purchase shares in the $2.7bn franchise after becoming the first team in the MLB to go public.
• Take a look behind the scenes of the scandal that forced a Stanford professor to resign.
• A recent poll found that 16% of voters would consider Joe Manchin as a 3rd party candidate.

Macro Monkey Says

The War on Business

Lina Khan is the Chair of the Federal Trade Commission (FTC), and she has one goal: destroy every merger deal in sight.

The independent oversight committee has the sole purpose of protecting consumers from anticompetitive business practices. Mergers and acquisitions fall under that scope, as they fundamentally change the competitive landscape, which impacts the little people, aka you-and-I.

If Company A and Company B are the only two businesses that sell a product, and Company A acquires Company B, they now have a monopoly on that product. This is something the FTC does not like, and will sue to challenge or halt the deal.

"Merger arbitrage is a popular hedge fund strategy whereby investors buy the stock of a company being acquired while shorting the acquirer."

Looking around at the deals landscape, they may have a point. Merger arbitrage is a popular hedge fund strategy whereby investors buy the stock of a company being acquired while shorting the acquirer. Once the deal is complete, the fund makes a nice return, and everyone is happy.

On the other side, companies would argue that mergers and acquisitions are an essential part of the business ecosystem and that they allow for innovations that help consumers in the long run.

Lina Khan has made a name for herself by taking the exact opposite view of that. Merger activity has slowed to a screeching halt in the past couple of years for many reasons, one of which is the fact that companies have been reluctant to act in fear that they’ll get sued. For sure, the FTC has built a pretty large pipeline of deals they are looking to block.

• Microsoft/Activision: Microsoft’s $67bn proposed acquisition of Activision is the most notable and has made headlines recently as the FTC lost its case. Regulators gave the companies the green light to continue. The FTC isn’t giving up that easily and plans to appeal that decision.
• VMWare/BroadCom: Things aren’t looking good for the FTC here either, as the $70bn deal received approval from UK regulators. Still, the FTC is persisting, and it will be a long road toward approval.
• Amgen/Horizon Therapeutics: The FTC also sued to block biopharmaceutical giant Amgen’s $27 billion acquisition of Horizon Therapeutics.

As you can see, there is a lot of money on the line, and given the ever-present bureaucracy baked into the system, these court cases delay the merger process by months or even years in some cases.

Oftentimes, both sides throw in the towel and walk away from the deal, at which point the acquiring company must pay a predetermined “break fee” for wasting the other company’s time.

"When one large deal gets approved, the rest of the deals in the merger-arb universe will trade up as well."

These three deals serve as somewhat of a “bellwether” for the entire industry. When one large deal gets approved, the rest of the deals in the merger-arb universe will trade up as well.

That is exactly what happened the other day when the FTC fell flat on its face in the high-profile Microsoft/Activation case. Lina Khan and her cronies over at the FTC argue that if Microsoft goes through with the purchase, Xbox will have too much market share in the cloud space, particularly because they would be purchasing the Call of Duty franchise.

In order to assuage those fears, Microsoft agreed to keep Call of Duty on PlayStation, and both sides called it a day. The deal was approved, and the FTC went home with their tails between their legs. WRONG. Well, the deal did get approved in the higher courts, but the FTC is, of course, appealing that decision.

For all intents and purposes, this is just for show, as both sides have cleared every hurdle they needed to. This high-profile loss was a big hit for the FTC, which has had a poor track record so far. And that’s what happens when you indiscriminately block every deal.

What's Ripe

Zion Bancorp (ZION) ↑ 55.62% ↑

• A little-known bank called Zion had its rags-to-riches story. It was the top-performing stock in the S&P 500 Thursday after customer deposits for Q2 beat analyst estimates.
• It was much-needed good news for the stock, as it came into the session down 30% YTD. While deposits rose, the other side of the story is that the bank’s funding costs also increased in lockstep.
• Funding costs are basically the amount of interest that banks pay on deposits in order to keep those deposits in-house. Zion’s interest-bearing deposit base increased by 19%. The average rate Zion pays customers increased to almost 2% from 0% a year earlier.
• Let’s face it, sometimes the only way to have friends is to pay for them. I wouldn’t shame Zion Bank for paying for customer deposits, and clearly, investors aren’t either based on the stock price.

Heritage-Crystal Clean (HCCI) ↑ 40.20% ↑

• Heritage hit a record-high after J.F. Lehman announced the purchase of the industrial cleaning and oil re-refining company in an all-cash deal for $1.2bn.
• A little extra education on merger arbitrage deals. Whenever a company purchases another company, it will always pay a premium to the most recent stock price. This premium is paid by the acquiring company for access to the assets and to compensate current shareholders. Clearly, if a business is acquiring another company, it is because they believe they will be able to make much more off of it in the long-term, so they are willing to pay that premium.
• J.F. Lehman & Co, which focuses on the industrials/aerospace and defense sectors, is paying an 8.5% premium for HCCI. Investors will purchase the stock of the company being acquired, HCCI in this case, and hold it until the deal is completed. J.F. Lehman is paying all cash for the deal, which is even better and makes for a cleaner transaction.

What's Rotten

Discover Financial Services (DFS) ↓ 15.71% ↓

• We all just discovered what happens to a stock when compliance issues take hold of your company. (You can sweep that joke under the rug and never let it see the light of day again.)
• The credit card company was in the cross-swipes of regulators due to compliance issues. And it’s a certified mess. Firstly, they were forced to pause a scheduled buyback and posted higher-than-expected Q2 charge-offs. The issues stemmed from the lender disclosing that it misclassified certain credit card accounts. They were “accidentally” placing customers into their highest pricing tier, meaning merchants were paying more than they should have. What’s worse, they’ve been doing this since 2007.
• An honest mistake or a wilful turning of the proverbial blind eye? It probably doesn’t matter, as the market is both Judge and Jury, and it issued a clear verdict through the stock price.

Tesla (TSLA) ↓ 10.36% ↓

• Following Tesla’s stock is basically having a front-row seat into Elon Musk’s net worth on a daily basis. As the top shareholder, owning over $100bn worth of stock, Elon lost more money in one day than we’ll ever make in two lifetimes. And he took it like a champ, which I suppose is easy to do when you have a few extra billions of dollars in reserve of that.
• Musk sent warning shots to investors that he will have to keep lowering prices on Teslas if interest rates continue to rise. The company has already experienced markdowns for the past few months, which have impacted the bottom line.
• In addition, investors were spooked by Musk’s plans to spend at least $1bn on a supercomputer called Dojo as well as being behind schedule for the Cybertruck. You’d think a seasoned Tesla shareholder would understand what they’re signing up for with Elon and not take it to heart/pocket. Let’s see if the stock bounces back like we’ve become accustomed to seeing it do.

Thought Banana

Netflix Cracking the Whip

Netflix is in a bit of a tizzy. Gone are the days of the old-school, community-based grassroots organization that allowed us to economically watch movies with all of our friends on one account. Now, Netflix is putting an end to the nonsense as it looks to separate itself from the competition.

Ok, I’m exaggerating. Netflix was never the warm and fuzzy company allowing people to share accounts with impunity. They’ve always been profit-motivated. They are a company, after all. So why are they just now, after years of operating, cracking down on password sharing? It has to do with the broader streaming/subscriber business model.

"As a business, they were focused on growth by any means, trying to grab as many eyeballs as possible in the crowded streaming space."

Starting off as a young company that delivered physical DVDs, Netflix adjusted its business strategy once the subscriber model took over. As a business, they were focused on growth by any means, trying to grab as many eyeballs as possible in the crowded streaming space.

This meant spending billions of dollars on purchasing TV and movie content for established shows as well as producing their own shows. By the way, most of Netflix’s investments don’t work out, but that’s just the price of playing the game.

Whether it’s Airbnb, Uber, or Netflix, companies that rely on subscribers have to lose money in the short term in order to gain loyal customers. Once they feel they have a distinct competitive advantage, they can flip the switch. Consider Netflix in flip-switching mode.

The company has said “enough” to password sharing and decided to finally put a stop to it as they look for new ways to increase the bottom line. The new policy limits the number of people outside of the primary account holder’s name that can share a subscription and requires the account owner to pay more to do so.

The policy has only been in place since May, but already Netflix has gained an additional 6mn subscribers. Imagine Netflix going full embarrassment mode and publishing a list of all 6mn people sharing passwords. Thoughts like this are probably the reason why I should never be a financial regulator.

In addition to the password-sharing crackdown, Netflix also did away with its $9.99 ad-free plan. For that service, consumers will now have to pay $15.99. They also introduced a $19.99 premium, ad-free plan with the highest-quality stream.

So far, this has raised net profit by 6% to $1.5bn, and free cash flow projections are forecasted to be $5bn from an earlier estimate of $3.5bn—still below investors’ expectations.

"So far, this has raised net profit by 6% to $1.5bn ..."

Why now? The reasons Netflix is ratcheting up the dial now are two-fold:

1. The Hollywood writers and actors’ strike means Netflix will be generating less original content, meaning there are fewer ways to drive subscriber growth.
   Other streaming sites are going to have the same issue, but those companies have slightly different business models. Disney, for example, doesn’t have to create that much new content because the platform largely relies on pre-packaged nostalgia from the past few decades.
2. The streaming field is getting crowded. When the cord-cutting revolution first materialized, consumers felt they were getting a bargain.
   Now, having to subscribe to Hulu, Netflix, Disney+, HBO, and Peacock makes customers feel like they might as well go back to paying for cable. The idea for Netflix would be to break to the top of the streaming food chain with a power play to become the dominant platform.

Banana Brain Teaser

Yesterday — My twin lives at the reverse of my house number. The difference between our house numbers ends in two. What is the lowest possible number for my house?

The lowest possible number for my house is 19.

Today — Find pairs of homophones using the descriptions given to you.

Example: A large omnivore and to be without covering. The answer is bear and bare.

• A board on hinges and the pattern of steps of a horse at a particular speed.
• Being just and money collected to pass.
• A form of precipitation and to rule.

Shoot us your guesses at [email protected] with the subject line “Banana Brain Teaser”.

Wise Investor Says

“Inaction and patience are almost always the wisest options in the stock market.” — Guy Spier

Happy Investing,

Patrick & The Daily Peel Team

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