Sunday, July 13, 2014

Shine On, You Crazy Diamond

Quick. What do you see?
Claudio: “Benedick, didst thou note the daughter of Signior Leonato?”
Benedick: “I noted her not; but I looked on her.”
Claudio: “Is she not a modest young lady?”
Benedick: “Do you question me, as an honest man should do, for my simple true judgment; or would you have me speak after my custom, as being a professed tyrant to their sex?”
Claudio: “No; I pray thee speak in sober judgment.”
Benedick: “Why, i’ faith, methinks she’s too low for a high praise, too brown for a fair praise, and too little for a great praise; only this commendation I can afford her, that were she other than she is, she were unhandsome, and being no other but as she is, I do not like her.”
Claudio: “Thou thinkest I am in sport: I pray thee tell me truly how thou likest her.”
Benedick: “Would you buy her, that you enquire after her?”
Claudio: “Can the world buy such a jewel?”
Benedick: “Yea, and a case to put it into.”

— William Shakespeare, Much Ado About Nothing

Matt Levine put an instructive and amusing post up at Bloomberg View two days ago on the nonsensical phenomenon which is CYNK that is worth your attention, Dearest of Readers, if only for a slow news Friday leading into a World Cup finals weekend. I recommend you enjoy it as an all-too-rare example of a financial journalist who actually tends to know what he is talking about trying to explain arcane and confusing epiphenomena of the financial markets to plebeians with wit and style. Levine, of course, is a former Goldman Sachs banker, which means, inter alia, that 1) he tends to know whereof he speaks (writes) and 2) you are free to disregard everything he writes as the sophistic outpourings of a confirmed agent of Satan sent to Earth to separate you and your orphaned, widowed Mother-in-law from any semblance of financial wherewithal and pin money. (These two things, by the way, are not necessarily mutually exclusive.)

Anyway, I have no particular interest in glossing Mr. Levine’s more than adequate gloss of this financial chicanery other than to point to a by-product of the CYNK story which features briefly in his story and which lesser mortals have been making quite the to-do about as this little passion play makes the rounds of Cialis-financed stock market news programs; namely, the purported market cap of this fraud professional short squeeze piece of shit security. As the Squid alumnus states,
Something about a company with no revenues and a brilliant but undeveloped business model (buy friends on the Internet! friends not included) having a $4, 5, 6, whatever billion dollar market cap struck me as fishy.
No shit.

* * *
In fact, if you segue on over to the font of all financial market wisdom, Yahoo! Finance,1 you will find that venerable market oracle calculates the market capitalization of this special snowflake without apparent substance or reason for being to be a delightful and highly substantive $4.05 billion as of Thursday’s “market” closing “price.” This is, of course, prima facie ridiculous, and it has been cited ad nauseam by every journalist and sundry whose secret brief and deeply held belief is that everything to do with the mysterious financial markets is bizarre, impenetrably obscure and opaque, and just plain dumb. On its surface, it is plain dumb, and, I am here to tell you, Delightful Readers, as your Guide to All Things Valuation, that the surface is all there is.

For a delicate glissade of the mouse over to CYNK’s historical price page on Yahoo! reveals that CYNK’s trading on Thursday (the last day of trading before exchange officials woke up from their bureaucratic pay scale-induced comas to ponder that something might not be quite right) occurred in a range of $9.80 to $21.95 per share for a total volume of 386,100 shares. Yes, that’s right, children, you read that right: 386 thousand shares. In other words, the blowout day of trading in a four billion dollar public company involved somewhere in the neighborhood of six million dollars2 of stock trading hands. Do you see the problem? Of course you do.

Imputing a “market value” to a public company on the price which obtains when 0.13% of its total shares outstanding actually trade is a dubious business, especially when it is clear that the supply of available shares is, as in this case, severely constrained. It would be another thing entirely if everyone holding CYNK’s 291 million other freely tradable shares looked at their Quotrons and said, “Huh. $21.95 per share. Yeah, that seems totally reasonable. I think I’ll hold my current position for future price appreciation potential.” But when supply is artificially constrained from meeting demand, the price which obtains in a market is not the equilibrium price, and the value which that price imputes is not the equilibrium value of the asset.

Microeconomics and common sense tell us that not everyone in the market for any asset must have the same individual supply and demand preference for that asset. There is some portion of buyers who are willing to pay more than the current market price, some sellers who are willing to sell below the current price, and many on each side of the market who are not. This is neatly illustrated by the following diagram of a hypothetical market operation, familiar to many a student who did not sleep through the first month of Micro 101:

The point is that there is a “market,” of sorts, at almost every quantity of asset supplied, and if the supply of willing sellers is abnormally constrained or abnormally bolstered, one should expect sales to occur along the buyers’ demand curve until a local “equilibrium” is found. That being said, a sensible person would not view such an abnormal market as a good indicator of the normalized value of the underlying asset in question.

So, therefore, one should firmly embed notions such as the “market capitalization” of short squeeze scams such as CYNK in pulsating neon scare quotes, so the great unwashed and their blinkered guides in the media do not take them as anything other than arithmetic exercises. So, also, one should not take reported implied market values from the technology economy, such as Series D or pre-IPO round investments by professional investors in vaporware startups, as anything other than the revealed price preferences of that particular investor in that particular company. The fact that Fidelity invested $100 million for a 1% stake in the illiquid equity of Doofr-rama does not make a strong case that Doofr-rama’s “value” is $10 billion. All it really tells you is Fidelity desperately wanted 1% of Doofr-rama. If you want to know why, you better go ask Fidelity.

* * *

Value is a highly subjective and evanescent thing, O Dearly Beloved, a fact which I have addressed in these pages before. Perhaps the greatest proof we have of this in the financial world is the unpredictable and often fraught process whereby private companies enter into the public agora via initial public offerings. What makes the rest of us take some comfort in the reliability of seasoned publicly traded stocks is that they are traded freely by and among hundreds if not thousands of individual investors daily, all of whom can express their wacky, idiosyncratic notions of value to the limit of their appetites and checkbooks, in competition and cooperation with other lunatics with contrasting notions, to their hearts’ content or distress during market hours. If there is some constraint or check on fully free trading, such as artificially constrained supply (e.g., CYNK) or a dangerous mix of newly released limited supply supported by underwriters’ legal stabilization techniques (e.g., every new IPO), the wise judge of value should look at any arithmetic calculation which purports to give such an entity’s worth with a gimlet and highly jaundiced eye.

The wisdom of crowds in the market, as everywhere else, does not arise from the wisdom of each and every member of the mob. It comes from the diversity of idiotic, ill-considered, and just plain dumb opinions held by everybody, which, by some thankful magic of human nature, usually tend to cancel each other out and supply a workable if not entirely transparent answer. It’s when we have only one lunatic, or a small handful, making value decisions that we tend to get the silly answers.

Of course, if you find that one special snowflake whose worth has no price, feel free to dive in headfirst. I won’t judge you: it’s your funeral. Just don’t expect the rest of us to follow.

Related reading:
Matt Levine, Cynk Makes the Case for Buying Friends, Naked Short Selling (Bloomberg, July 11, 2014)
Go Ask Alice (September 14, 2013)

1 Yes, I am aware that such a citation perhaps does not give you a great deal of confidence you are dealing with a professional’s considered opinion, but 1) it’s probably close enough, and 2) you don’t really think I’m going to spill my special secret top quality financial data sources into this pig trough, do you?
2 Based on the clearly incorrect assumption all 386,100 shares traded at the average of the high and low prices of the day. The correct calculation would involve what is know as the volume-weighted average price, or VWAP, of shares traded. But in order to get that, you would have to subscribe to a real market data service, for which you are definitely not paying me in your current subscription price. My ballpark estimate is close enough.

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