longwave

MARK ZUCKERBERG, Facebook’s chief executive, had something other than his firm’s initial public offering (IPO) to celebrate this weekend when he married Priscilla Chan, his long-standing girlfriend. Unfortunately for Mr Zuckerberg, investors seem less than firmly wedded to his social network's equity. On May 21st Facebook’s shares finished trading on the NASDAQ stockmarket at just above $34 each, some 11% below the company’s $38 listing price, after dropping as low as $33 earlier in the day. This is deeply embarrassing for everyone involved in one of the biggest public offerings in corporate history.

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LIKE many unhappily married couples, Yahoo! and Alibaba have not found it easy to divorce. The American online firm owns roughly 40% of the Chinese e-commerce giant, but both sides have had misgivings about the relationship for years. All of Yahoo!’s many recent chief executives have tried to find a clever way to sell off the stake. Jack Ma, Alibaba’s flamboyant boss, for his part, has been dreaming of winning outright control of the firm he founded from Yahoo! and Softbank, a Japanese firm that controls about 30% of Alibaba. But there always seemed to be something—tax issues, valuation—that got in the way of a deal.

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OUR correspondents discuss Facebook's initial public offering and the future of the public company

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The Council on Tall Buildings and Urban Habitat (CTBUH) in Chicago is the world’s arbiter of all things tall. They keep endless, ballistic statistics on tall buildings of all kinds, and make official, industry-recognized decisions about whose building is The One.

The 20 tallest buildings completed in 2011 point to a new 1960s-style “Golden Age” that’s just around the corner. Click

For example, last month the CTBUH announced that the new One World Trade Center tower in New YorK City (at Ground Zero) might not become the tallest in the Western Hemisphere after all because the 408 foot antenna atop the building would not be enclosed in an architectural spire; according to the CTBUH, spires count, but antennas sans spires don’t (Wall Street Journal, C. Bialik, 5/12/12).

Indeed, such erigible esoterica is of considerable significance as we at 21stCenturyWaves.com continue our development of a global ebullience index.

This is because — over the last 200+ years — large Macro-Engineering Projects (e.g., Panama Canal) and Great Explorations (e.g., discovery of the N and S poles) appear to be triggered by large economic booms, but are fundamentally driven by “ebullience” (e.g., “Panama fever”, “pole mania”) — a somewhat irrational, but highly positive view of the future.

For example, In the 1960s Apollo program and Peace Corps of John F. Kennedy it was the ebullient feeling that we could do almost anything; in the early 20th century it was Theodore Roosevelt’s Panama fever and (north & south) pole mania; in the mid-19th century it was manifest destiny of James Polk and the central Africa adventures of Dr. Livingstone, I presume; and about 200 years ago it began auspiciously with Jefferson, Napoleon, and Lewis & Clark.

Earlier this year at the University of Southern California an internationally recognized architect confided to me that erecting tall buildings is usually more about egos than profits.

The CTBUH executive director agrees and the early abullience shown by Saudi plans for the first kilometer supertower — that bests the current tallest Burj Khalifa in Dubai by 500+ feet — and other recent extraordinay endeavors suggest we are indeed headed for a new 1960s-style “golden age”.

For example, in their annual review (for 2011) of tall building trends, the CTBUH noted: 1) 2011 continues the trend since 2007 that each successive year has more 200 meter+ buildings completed than ever before; this record-setting pace is now expected to continue even through the current great recession.

Looking to the future, it is now foreseeable – indeed likely – that the recent trend of an annual increase in building completions will continue for the next several years, perhaps even through the end of the decade. This represents a change in recent predictions. It had been expected that skyscraper completions would drop off very sharply after 2011, as a result of the 2008 global financial crisis and the large number of projects put on hold. Now however, due in large part to the continuing high activity of skyscraper design and construction in China, as well as the development of several relatively new markets, this global dip is no longer expected.

2) Global shifts in the locations of the top 100 buildings are significant. For example, Asia (with 46) is edging toward 50% of the all top 100 towers, and the Middle East increased by three, while Europe dropped to only one building in the top 100.

3) While China remains a dynamic market for 200 m+ buildings, its production declined from 33% in 2010 to only 26% in 2011, which indicates the market is diversifying. For example, Panama — site of one of the most ebullient MEPs in the world today: the Panama Canal Expansion Project — is enjoying a 200 m+ spurt:

Before 2008, no 200 m+ buildings existed in all of Panama. Then, between 2008 and 2010, three buildings opened. In 2011, Panama City completed ten 200 m+ skyscrapers, more than any other city and more than double the number of completions in all of North America. With these completions, there are now 12 such buildings in Panama, perhaps signaling a new day for the tall building in this region.

The CTBUH Summary for 2011 concludes by forecasting a decade-long surge in tall buildings around the globe.

With over 300 projects above the 200-meter mark currently under construction internationally, the tall building community is set to continue to develop at an incredible pace. As new markets continue to discover and develop the tall building, it is quite possible that this pace will continue through the end of this decade. Without a doubt, the skylines of the world will see tremendous change by the year 2020.

The tall building community sees beyond current global economic difficulties to a more ebullient 1960s-style “golden age” that will sparkle into the 2020s. It’s called the 2015 Maslow Window and will also feature the new international Space Age.

INVESTORS have gotten used to a swift run-up, or “pop”, in the share price of tech firms that stage an initial public offering (IPO). But doubts swirling around Facebook’s business model meant that the giant social network’s stock failed to take off as some had expected on its first day as a public company on May 18th. Instead the IPO’s underwriters were forced to step in to prevent the shares slipping below their offer price of $38 as trading progressed on America's NASDAQ stockmarket. At the market’s close they were swapping hands at $38.23, giving the company a market capitalisation of $105 billion.

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THE truism that banking is a confidence game barely needs repeating. Yet occasionally both bankers and their regulators need to be reminded of this. Two events this week show why.

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IT IS unlikely to keep Facebooks IPO rocket from taking off. But General Motors’s decision to scuttle its ad campaign on Facebook highlights the big question about the service, which now boasts more than 900 million users who log in at least once every month: Will the firm find a way to make enough money off its huge audience? 

GM was spending an estimated $10 million annually on Facebook (digital marketing now consumes about 30% of GM’s estimated $3-4 billion marketing budget). A routine marketing review concluded that the site delivered “insufficient” results, confirmed Chris Perry, marketing chief for Chevrolet, GM’s largest global brand. 

When judged by conventional ad metrics Facebook clearly has a hard time making its case. But it would be wrong to dismiss the social-media world’s 800-pound gorilla, cautions Scott Monty, who is in charge of social media at Ford. In a carefully worded Twitter message, he acknowledged that when measured by industry standards—as a “straight media buy”—Facebook does not pan out.  But “that’s the wrong way to think about it,” he stressed in a later interview, suggesting that GM might be using outdated logic to measure its social-media results.

 “In our experience, if you combine engaging experiences with unique story-telling and paid content, Facebook becomes very effective,” explains Mr Monty, noting that Ford has used the service in a variety of innovative ways that are not possible with traditional media. For instance, Facebook was the digital backbone for the introduction of the carmaker’s new Explorer sport-utility vehicle a year ago. “We had a bigger impact than if we had run a Super Bowl ad,” says Mr Monty. The campaign generated close to 400m individual page views on Facebook, Ford’s website and other digital properties.

That viewpoint was echoed by the senior media buyer at a major Detroit ad agency, who asked not to be identified by name because he is not authorised to discuss strategy with the press. Based on clicks-throughs alone, he says, Facebook “doesn’t pay off.” His agency’s approach is to use the service as part of broader social media campaigns.

GM’s decision to pull its ads off Facebook has given Ford the opportunity to make its arch-rival seem, well, a bit out of touch with the latest digital trends. It is payback time for the way that the Chevrolet division embarrassed Ford with a Super Bowl ad. It played on the Mayan calendar's prediction that the world will end in 2012:  Survival depends on driving a Chevrolet Silverado—a Ford F-150 pick-up truck does not get its passengers to the meeting point.

ONE of the success stories in retail banking over the past decade has been the expansion of TD, Canada’s second-largest bank, along America’s eastern seaboard, fuelled by such basic ideas as longer opening hours and service that is better-than-halfway decent. But a fraud case in Florida threatens to sully the reputation of the firm known to millions as “America’s Most Convenient Bank”.

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The chairman of Berkshire Hathaway discusses his motivations for giving wealth away, history's great philanthropists and why his tax return is not a factor

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Our correspondents discuss how new technologies will affect the future of retail banking

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“ZUCKERBERG’S rocket, ready for lift-off” was the title of our article about Facebook’s upcoming initial public offering (IPO) that ran in last week's issue of The Economist. As the first day of trading in its shares, expected to be May 18th, approaches, the rocket’s payload is getting bigger. On May 16th the social network revealed it was boosting the number of shares available by 25%, to 421m, on the back of increased demand. Its bold move is a sign that investors’ hunger for Facebook’s equity could turn its IPO into one of the biggest in American corporate history.

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A RARE slip-up by lawyers has helped to shed some rather interesting light on a high-profile legal battle, the details of which some of the largest Wall Street firms have been fighting to keep under wraps. In 2007 Overstock, a Utah-based online retailer, sued a dozen big brokers, alleging that they had caused its share price to fall sharply by helping their clients to engage in “naked” short selling.

In a normal short sale, the shares are borrowed (or at least “located”) with a broker’s help before being sold. In the naked version, there is no attempt to pre-borrow the stock or even check that it exists. This can create “fails to deliver”, where the trade is not settled when it should be because there are not enough actual shares available for delivery. This messes with the laws of supply and demand, allowing shorting to take place beyond the natural limits set by the number of borrowable shares. Regulators have long frowned upon naked shorting. The rules against the practice have been tightened up a number of times over the past seven years.

As the pre-trial discovery period proceeded, Overstock narrowed its focus to two firms, Goldman Sachs and Merrill Lynch, now part of Bank of America. Just before the case was set to go to trial in California, however, the judge dismissed it on jurisdictional grounds, ruling that not enough of the alleged wrongdoing had taken place in the state. Overstock appealed and pushed for all of the evidence to be unsealed. The defendants argued that virtually everything should remain sealed, in part because the documents contained “trade secrets”. Four media groups, including The Economist, jointly opposed a motion to seal on public-interest grounds. The judge decided that some of the documents should be released but stayed his ruling, pending appeal.

That was how things stood until the end of last week, when the defendants’ lawyers sent their opposition to a plaintiffs’ motion to the other parties in the case. One of the exhibits attached to this, presumably inadvertently, was an unredacted version of an earlier filing by Overstock, opposing the defendants’ motion to seal papers. Within this exhibit is an intriguing six-page section, “Facts Defendants Improperly Seek to Seal” (pages 14-20 of this), containing excerpts of emails written by Goldman and Merrill employees.

In a number of these, they discuss deliberately failing to settle client trades. One Merrill executive suggests the firm “might want to consider allowing…customers to fail,” to which a colleague replies: “We are going to look into that.” Another asks: “How and when can we prevent the delivery [of shares]?” In another email he requests an update from a lieutenant on “how we are going to fix fails and I want to know what we nees [sic] to do to make 369 market makers fail.” In response to a question from a large client about efforts at “cleaning up” fails, a Goldman man says that “we will let you fail.” In another message, he refers to a senior colleague “really backing down from…cleaning up fails.”

Compliance officers repeatedly questioned this behaviour, according to the filing. A Merrill compliance person is quoted describing it as “totally unacceptable—we are failing when we have over a million shares of stock available…Is there a blanket agreement that we allow every market maker client to continue failing even if there is enough availability?” She adds that fails need to be “cleaned up regardless of who is causing them.”

The emails also suggest close commercial links between the two firms and at least one trading outfit that was a target of regulatory probes into shorting violations, SBA Trading. In one message, a Merrill employee forwards a sanctions order against SBA’s Scott Arenstein to a counterpart at Goldman, referring to Mr Arenstein as “our boy” and asking: “You think there will be any fallout on clearing firms?” The Overstock filing also refers to a telephone transcript in which a Merrill compliance officer and a colleague discuss the fact that Mr Arenstein’s “recycling” of short sales is “not okay”. In another email, the deputy head of Goldman’s securities-lending group describes Mr Arenstein as being “the other side of a lot of our activity.”

Other missives suggest a cavalier attitude to the rules. In a 2005 email, the president of one of Merrill’s stock-clearing businesses responds to internal concerns about the intentional failing of short sales thus: “Fuck the compliance area—procedures, schmecedures.” He has since assured the court that this statement was a joke, according to the filing.

Goldman and Merrill have denied throughout that they participated in any sort of naked-shorting conspiracy. Their supporters argue that the legal action brought by Overstock is a crude tactic by Patrick Byrne, the retailer’s mercurial boss, to divert attention away from its long history of underperformance. (The firm continues to struggle, despite no longer being plagued by settlement failures.) Some question the link between failed trades and naked shorting, arguing that fails are generally the result of operational problems and other factors rather than naked nefariousness.

Nevertheless, the release of the email excerpts will have done the brokers no favours. They suggest that trades were being intentionally failed; that some of those involved were aware regulators would not look kindly upon some of the activity; that some of the firms’ internal policemen were unhappy with the explanations they received for the proliferation of fails; and that at least one senior executive appeared to have an unusual attitude towards compliance.

The emails are just a very small part of the communications and other material unearthed during the four-year discovery process. If the court of appeal unstays the partial unsealing order, there will be much more to pore over, shining more light on an issue that has hitherto been as frustratingly murky as it has been controversial.

A LARGE, mistaken, trading position take by J.P. Morgan, one of America’s leading banks, already costing it more than $2 billion has become a weapon in major battles in Washington and the financial markets.

In Washington a crowd of politicians has used the incident to argue for more government involvement in banking, even if the ideas floated are muddled or counter-productive. In the financial markets the response has been more focused and carnivorous as other financial firms are trying to get ahead of any move Morgan might make to extricate itself from its trade. The company’s share price, already down more than 9% on May 11th after the initial revelations, fell another 2% on early trading when markets reopened after the weekend on May 14th.

Morgan response to the incident has come on multiple levels. Jamie Dimon, its chief executive, appeared on a popular news show on Sunday to acknowledge fault for the trade (“a stupid thing that we should never have been done”), but also provide reassurance (“…but we are still going to earn a lot of money this quarter. So it isn’t like this company is jeopoardised…”). Morgan’s capital position does indeed remain strong and it is projected to earn record earnings for the year.

Internally, Morgan made key executive changes. The head of the department arranging the trade, Ina Drew, abruptly retired. A special committee to direct the response to the trade was established under the bank’s former chief financial officer Mike Cavanagh, often rumoured as the leading candidate to one day succeed Mr Dimon. This will certainly be a trial by fire.

In the financial markets, various obscure indices tied to credit default swaps moved abruptly, as other firms took bets on what comprised Morgan’s trade, and whether it was vulnerable to a squeeze. That raised the possibility of the loss quickly expanding. Under accounting rules they must be constantly marked to market.

A key questions are whether Morgan has the fortitude to withstand the short-term pain of trading-induced price movements that are not tied to the value of the assets underlying the swaps, and how much value in these assets really does exist. So far, Morgan has believed its efforts to minimise the damage from the trade would benefit from keeping information of its components from the broader market. Meanwhile, other banks have begun re-examining their own trading positions to ensure a similar problem cannot emerge.

OUR correspondents debate Greece's latest difficulties, the Spanish government's attempts to bolster the country's banks and JPMorgan Chase's controversial trading loss

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CRITICS of Yahoo! had hoped that when Scott Thompson, a former senior executive at Paypal, an online payments company, took over the helm of the web giant in January, he would bring some badly needed stability to a business that had been struggling for years to turn itself around. But on May 14th Yahoo! announced that Mr Thompson was leaving the firm after news of his impending departure leaked on a tech blog, AllThingsD.

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[Note:  A version of this column recently appeared in the Shift Age Newsletter.  Please feel free to sign up for a free subscription.]

I have been writing and speaking that IP is the wealth of the Shift Age for the last six years.  And over the last six years, this reality has become ever more apparent.  Recent headlines make this crystal clear.

In the Agricultural Age, those who owned the land created wealth.  In the Industrial Age, those who created and controlled production created wealth.  In the Information Age, those who created technology and brought it to market created wealth.  In the Shift Age, those who create or own Intellectual Property will create wealth.

Nine times I have spoken of this and have had a CEO or business owner tell me they had recently sold their company for more money than they had ever thought possible based on multiples of revenue or profit.  The reason was that the strategic buyer had a clear perception of the ability to scale up the seller’s IP and paid for that opportunity.

IP now represents more than 80% of the market cap of the S&P 500 in the United States.  People are finally understanding that corporate wealth – and revenue – is increasingly based on what Intellectual Property the company owns.

One of the recent examples of this is the Microsoft-AOL transaction.  Microsoft paid AOL more that $1 billion U.S. for 800 patents, or $1.3 million per patent.  Microsoft wanted the patents as they related to the Internet and most important, to smartphones and mobile operating systems.  AOL, moving toward a more pure content-intensive business, monetized this incredibly valuable collection of IP assets from its earlier iteration to fund its new direction.  Both sides won.

What is interesting is to look at the motivation of Microsoft.  Microsoft became a giant on the power of a near monopoly of PC-based software.  The Internet transformation put the company back on its heels, lessening its dominance with increasingly Web-centric businesses and individuals.  Now that the world has, is and will continue to rapidly move toward mobile devices and platforms, Microsoft again finds itself playing catch-up.

If one thinks about the businesses and revenue streams of the mobile business, Microsoft is behind in all the traditional categories.  The carriers own the revenue stream of access.  Google and Apple dominate the operating systems, apps and software platforms of the smartphone business.  Apple, Samsung, Motorola/Google, HTC and others lead in the device business.  Microsoft doesn’t make phones and has a single-digit share of the OS market in mobile.  So, essentially, the company is not a factor in any of these standard revenue streams of mobile.  That is why its purchase of AOL’s patents, on the heels of other patent deals in the last couple of years, is so brilliant.

Smartphones utilize dozens of patents for the device and for the OS.  It is one of, if not the most, cross-licensed technology businesses relative to patents.  It is also one of the most legally contentious areas of patents.  Microsoft, with its huge and expensive purchase of AOL’s patents, on top of all its other recent patent purchases, has essentially created a huge revenue stream of licensing revenue in the mobile arena.  The company is rapidly moving to the position of being paid for almost every smartphone’s technology or OS.  Using its huge amount of available cash, Microsoft has effectively created a new revenue stream from a business in which it has not been successful, let alone dominant.

Microsoft doesn’t have carrier, device, or OS revenue, but it now is creating a huge stream of IP revenue – a patent-protected source of revenue not at risk due to the perpetually and rapidly changing mobile marketplace.  No costs of production, no costs of marketing, no costs of software development – just a huge investment into patents.  A quintessential Information Age company is developing Shift Age revenue.  Brilliant!

Welcome to the Shift Age!

J.P. MORGAN, widely considered the best run of all the large banks in America, if not the world, on May 10th provided the kind of news that has become all too common in the financial industry: a $2 billion charge for errant trades. The markets responded within seconds of the opening on May 11th, sending Morgan’s share price down 9%, and its value by $14 billion. Late on May 11th, Standard & Poor’s announced it was downgrading the outlook for the company, and Fitch knocked down its ratings.

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JPMORGAN, widely considered the best run of all the large banks in America, if not the world, on May 10th provided the kind of news that have become all too common in the financial industry: a $2 billion charge for errant trades. The markets responded within seconds of the opening on May 11th, sending Morgan’s share price down 9%, and its value by $14 billion. Late on May 11th, Standard & Poor’s announced it was downgrading the outlook for the company, and Fitch knocked down its ratings. But while none of these moves were trivial, they were hardly calamitous. The share price decline was sharp but finite. Morgan’s rating remains among the strongest in the industry. Its capital ratios are robust. And even after the loss, it is still expected to earn more than $4 billion in the current quarter, and produce record earnings for the year. There are no indications that customers were harmed or operations impaired. The bluntest criticism of Morgan’s failure came from the bank’s own chief executive, Jamie Dimon. He said the losses were the result of self-inflicted “sloppiness”, “poor judgment” and “stupidity”, for which “we are accountable”. Like all large financial institutions, Morgan is already crawling with bank inspectors and other regulators, but—perhaps to deflect potential blame—there were hints of investigations to come. The Securities and Exchange Commission announced it would take a look, as did the Commodities and Futures Trading Commission. Retiring congressman Barney Frank took a final turn in the limelight, asserting Morgan’s loss justified the imposition of ever more regulation. At least one plaintiff law firm trolling for clients announced its own investigation. And yet for all of this, it is hardly clear what Morgan did wrong. The bank has been careful to avoid providing details, not least to protect its ability to unwind positions. But it appears that the losses were the product of two separate efforts, both—in theory—appropriate. The first was to create a hedge against the bank’s exposure to high quality loans. This is an unconventional strategy for a bank, albeit one that, in principle, is a sound one. The second move—and the one that may have gone badly wrong—was an effort to ameliorate the first hedge, providing more economic exposure. Losses mounted in recent months, suggesting that the resurgence of global economic problems may have played a role, along with badly executed —and mistaken—trades. Ideally, a hedge works in any environment. This one, no matter how well intentioned, failed. Quiet changes in personnel are expected. Yet accusations were widespread that the trades were more likely directional bets that went wrong. Such moves would violate the spirit of the so-called “Volcker Rule” now being put in place to keep banks from speculating with deposits and instead trade only to further clients interests. Mr Dimon emphatically denied this, but those interested in evidence will have to wait until mid-summer, when details will be provided after the next earnings release. In the meantime, Mr Dimon warned that many particularly volatile components of the bad trades were still on the bank’s book, and would be until their genuine value could be realised: “We have staying power, and we are willing to use it.” Good thing too, because, he added, more mistakes were inevitable. So too now are the howls.

RUCHIR SHARMA, author of "Breakout Nations", explains how to predict which emerging markets will do better than others

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AS TURNAROUNDS go, this was pretty quick. Less than two weeks after the Bank of Spain sent its banking supervisors on a quick tour of financial capitals to convince investors that the country's banking system was sound, the government had nationalised the biggest of its struggling lenders and had ordered the country’s banks to set aside another €30 billion against bad loans on their property books.

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