TheChek News Flow

Small-cap stocks surge in expectation they will benefit disproportionately from a Fed interest rate cut

Giant technology stocks are “no longer the only game in town”, according to investors who over the past week have moved out of the megacaps that have driven the market rally for years in favour of smaller companies and other previously unloved sectors.

The Russell 2000 small-cap index has jumped 7 per cent since last Thursday, in a dramatic market shift sparked by falling inflation and encouraged by an improving earnings outlook.

Meanwhile, the so-called Magnificent Seven — megacap tech stocks that have dominated the blue-chip S&P 500 index’s gains over the past year, fuelling anxieties about an increasingly lopsided rally — have fallen. The losses, exacerbated by a global sell-off in semiconductor companies, came as the majority of other stocks in the index have climbed, led by sectors such as financials, energy and real estate. 

“All of a sudden we have a larger menu to choose from, whereas last year there was really only one thing on the menu,” said Jurrien Timmer, director of global macro at Fidelity. “When you have a more broad-based earnings recovery and a Fed pivot at the same time and the bond market is being well-behaved, there are other things to buy now too.”

Investors have long been hoping for a broadening out of gains in the US market. The S&P 500 advanced 14 per cent in the first half of 2024, but the reliance on a few large companies raised concerns about the fragility of the rally.

While passive fund investors profited, for active fund managers the narrowness of the rally made it difficult to keep up with their benchmarks, because so few companies outperformed the overall index and many managers were wary of holding such large positions in just a handful of stocks.

Inflation data published last week solidified investor hopes of an interest rate cut in September by the Federal Reserve. Smaller companies have particularly benefited from the shift in expectations because groups in the Russell 2000 tend to have higher debt burdens than large-caps. While lower rates have also traditionally been good news for fast-growing tech companies, many of the largest ones have received a boost to earnings from high interest rates because of their enormous cash piles.

Gains over the past week have been broad-based, with more than 1,500 of the nearly 2,000 companies in the Russell index rising. The equal-weighted version of the S&P 500, meanwhile, has outperformed the benchmark index, climbing almost 3 per cent, while the cap-weighted version fell.

Some market participants say the violence of the market rotation is partly a result of investor positioning; analysts at Bank of America noted on Thursday that short covering was a crucial driver of the rally in the Russell 2000 in particular, with heavily-shorted stocks among the best performing.

“I think a lot of people were caught offside,” said Brandon Nelson, a portfolio manager at Calamos who specialises in small- and mid-caps. “There was some complacency with people parked in the megacaps and ignoring or even shorting small-caps, because that had been the right pair trade for so long.”

Meanwhile, having fallen well behind the earnings growth of the Magnificent Seven last year, other companies’ profits are now improving as megacap tech stocks’ earnings growth slows.

“The rest of the [S&P 500] was in a technical profits recession last year,” said Savita Subramanian, head of US equity and quantitative strategy at Bank of America. “As growth broadens out we think investors should become a little bit more price sensitive and move towards these cheaper, more cyclical companies.”

However, it would take a brave investor to write off the prospects of further positive surprises by the megacap tech stocks. 

Nvidia dropped 13 per cent in the five trading sessions following last Thursday’s data showing a sharper than expected fall in US inflation. The last time it suffered such a large fall over a five-day period it followed it up with a 72 per cent rise over the next two months.

Jim Tierney, a growth-focused portfolio manager at AllianceBernstein, said the underlying trends that had driven growth in the Magnificent Seven and other artificial intelligence-linked stocks “are very much intact”, but suggested the relative strength of their earnings compared with the rest of the market was likely to wane.

“From a fundamental perspective the Magnificent Seven is no longer the only game in town where you can find growth,” he said.

Although many investors have been waiting for a sustained broadening out of gains, it may not mean good news for the overall index. More than 350 of the stocks in the S&P 500 rose in the week following the inflation release, but the index itself dipped 1.5 per cent because of the heavy weighting of the largest tech groups.

Whether the index can keep rising “depends whether new money is coming into the market and chooses to be in other stocks rather than the Magnificent Seven, or if it’s all an internal rotation where investors sell the Mag Seven to buy everything else”, said Fidelity’s Timmer.

He and several other analysts also highlighted the delicate balance required for smaller companies to keep rising: they need the Fed to start cutting rates, but without a big economic downturn that could damage their earnings. Market moves on Thursday highlighted this risk, with the Russell 2000 falling back 1.9 per cent after data showing jobless claims at their highest level since 2021.

Even after the gains over the past week, small-caps and the equal-weighted version of the S&P 500 are still trailing well behind the benchmark S&P 500, and investors are wary of getting carried away.

“You’ve closed the gap a little bit in the last week,” said Nelson at Calamos. “But you can’t undo years of underperformance in five days.”

J. Michael Cline, the co-founder of Fandango and multiple other startups over his multi-decade career, died after falling from a Manhattan hotel, New York’s Deputy Commissioner of Public Information tells TechCrunch.

The New York Police Department responded to 911 calls from the Kimberly Hotel, a 30-story hotel on 50th street in midtown Manhattan on Tuesday morning. Upon arrival, “officers found an unconscious and unresponsive male with injuries indicative of a fall from an elevated position,” the Deputy Commissioner said in a statement emailed to TechCrunch. Cline fell from the 20th story of the hotel, according to The New York Times. Emergency medical services responded and pronounced the individual dead shortly after arrival, and an investigation remains ongoing. Police later identified the individual as James Michael Cline, 64-year-old resident of Palm Beach, Florida.

Cline co-founded Fandango, the popular online ticketing company that revolutionized how Americans purchased movie tickets, alongside his chief operating officer Art Levitt in 1999, according to his LinkedIn page.

After a decade-long battle with MovieTickets.com during the 2000s, Fandango emerged as the winner of the online movie ticketing space. Cline pioneered a digital empire by selling movie tickets online, charging processing fees and selling online ads to turn a profit. Fandango removed the need for people to wait in long lines at box offices, and paved the way for the $37 billion online ticketing industry.

He left the company in 2011, roughly four years after the company was acquired by Comcast. Some early investors in the online ticketing service were General Atlantic and TCV.

Cline was also managing partner of Accretive, a venture capital firm he founded in 1999. He built startups throughout his career, including R1 RCM, Accumen, Accolade, Everspring, Dresr and Insureon. Starting in 2018, Cline served as the executive chairman at the venture firm Juxtapose, which invests in technology businesses. During his time there, Cline enjoyed investing in healthcare companies, according to his staff page. Some of Juxtapose’s portfolio companies include Tend, Nectar and Great Jones.

Accretive, Juxtapose and Fandango did not immediately respond to TechCrunch’s request for comment.

The presence of Amazon and Salesforce could complicate approvals for HBC’s move to merge Saks and Neiman Marcus.

After years of rumors, back-and-forth talks and a rush of creative fundraising, Richard Baker got his deal to buy Neiman Marcus for $2.65 billion this month.

But before he can close and combine Neiman’s with Saks Fifth Avenue to form Saks Global, he has to get the transaction past one more obstacle — the Federal Trade Commission.

And Baker’s hard-fought deal for Neiman’s has come together just as FTC regulators have sharpened their focus on corporate dealmaking and fashion, where Tapestry Inc. is now fighting to keep alive its $8.5 billion acquisition of Capri Holdings.

The combination of Saks and Neiman’s — particularly since it’s being funded in part by Amazon and Salesforce — promises to alter what’s left of the world of department store retailing.

“Department stores are a 19th-century phenomenon struggling to survive in the 21st,” said Susan Scafidi, founder and director of the Fashion Law Institute at Fordham Law School. “Acquisition by Saks may be the best way for Neiman’s to avoid joining the B-list of luxury retailers that have disappeared over the past decades, including Barneys, Henri Bendel and Bonwit Teller.”

Even so, regulators are expected to take a hard look at the deal.

“The fading sepia tint of the department store business model, however, does not exempt the sector from antitrust oversight,” Scafidi said. “Antitrust enforcement is an FTC priority at the moment, and a key lesson of the legal challenge to the proposed Tapestry-Capri merger is that the agency is inclined to define relevant market sector very narrowly.

“If Neiman’s and Saks are arguably the only two truly luxury brick-and-mortar department stores left standing, even in a weakened state, the deal is likely to face significant skepticism,” she said.

An Expected Second Request

Antitrust experts say regulators are likely to at least make a “second request” for more information on the Saks-Neiman’s deal — an exacting process that can take anywhere from eight months to a year before the FTC will decide to let the acquisition close or to challenge it in court.

While a second request might have once been a remote concern, fashion and retail are now very much on Washington’s radar.

Tapestry signed its deal to buy Capri in August, received a second request for more information from the FTC in November and was then hit by a lawsuit seeking to stop the deal in April.

The Tapestry-Capri case turns on the definition of the “accessible luxury” market — and would a deal that brought together Tapestry’s Coach and Kate Spade brands with Capri’s Michael Kors put the combined company in a position to dominate that market. (The combined company would also own the more luxury-oriented Versace, Jimmy Choo and Stuart Weitzman brands.)

Jeffrey Oliver, a partner at Baker Botts who earlier in his career was a staff attorney at the FTC’s Bureau of Competition, said regulators looking at the Tapestry-Capri transaction drew a “small circle” around the market of affordable luxury.

“That’s the playing field in which antitrust takes place,” Oliver said. “How big or small do you draw those circles? We call them markets, but they’re just kind of circles in which you decide these products are in.”

Everyone selling goods inside that circle are considered competitors. What that circle looks like in the case of Saks-Neiman’s is still anybody’s guess — outside the FTC — but market definition is not the only issue that antitrust experts are watching as regulators review the Neiman’s buyout.

“I would say the likelihood of a very extended investigation is very high, not only because you’ve got number-one and number-two luxury fashion retailers combining here, but also because you’ve got Amazon in the mix now,” Oliver said. “That absolutely complicates things, partly because it’s Amazon and there’s obviously no shortage of skepticism of Amazon’s intentions in the federal government, but also because it complicates the story as to why this deal should go forward.

“The deal was likely to get a second request even without Amazon’s participation,” he said. “But I think with Amazon’s participation, it’s virtually impossible to avoid.”

Regulating Retail

Although fashion deals have not faced many regulatory challenges in the recent past, retail is familiar territory for the FTC, which earlier this year sued to block Kroger Co.’s $24.6 billion acquisition of the Albertsons Cos. Inc. on anticompetitive grounds.

That case, bringing together two grocery store giants, might speak to a “need” while the combination of Saks and Neiman’s could look like the regulation of a “want,” but the government has the latitude to take all businesses seriously.

“I do worry that the transaction is going to look more like Kroger-Albertsons” when reviewed, said Jonathan Lazarow, antitrust lawyer and cochair of Ambrose, Mills & Lazarow’s Corporate Group.

“You might say, ‘They’re savvy consumers, they’re rich,’ but who’s going to get hurt is the smaller emerging brands,” Lazarow said. “Do they have monopoly-like powers? Are they able to define the market? I think [the FTC is] going to come back and say, ‘Yes.’ To me, this is a significant issue that needs to be addressed and I don’t know how they’re going to do it. There’s only so many designers out there.”

Just as vendors will find themselves with fewer choices if Saks and Neiman’s merge, the retailers’ highly skilled luxury salespeople and other employees would likewise see their options narrow.

When it revealed the deal, the Baker-led HBC, which already owns Saks and plans to buy both Neiman’s and Bergdorf Goodman, said the deal would support both established and emerging brands.

“For over 100 years, Saks Fifth Avenue, Neiman Marcus and Bergdorf Goodman have been deeply committed to helping luxury consumers discover the latest fashion from established and emerging designers,” the statement said. “Through its improved ecommerce experience and well-located store fleet, Saks Global will help emerging and established brands reach their target customers.”

The company also said that the combination would “offer value and career development opportunities to employees.”

Darrell Prescott, an attorney and antitrust expert who has worked in the fashion industry for years, said: “Typically in retail, antitrust matters would be resolved by just selling off stores and locations where they are in close proximity or they compete with one another or overlap. I don’t think it’s going to be that simple here.”

Prescott said the FTC might choose to set aside the issue of market definition that is already being tested in the Tapestry-Capri case and pursue another challenge that “is based primarily on the elimination of competition between the two parties. That’s a judgment call to be made by the prosecutors.”

While there are so many things already changing in Washington — and much more could be on the way given the especially divisive presidential election cycle — the regulatory machinery is already awhirl and the authorities are expected to start looking into a Saks-Neiman’s combination before the election.

“In the end, this will not be a question of the discretion of whoever populates the antitrust division at [the Department of Justice] or the competition bureau at the FTC,” Prescott said, “but a question of what a federal court will do with the case and the law. Despite efforts to make new law and revive old law, the precedents have not changed greatly and they are still on the books and they’re still binding.”

Up until now, Baker’s dream of buying Neiman’s relied on financing and some dealmaking chops. If the FTC challenges the acquisition, it will rely on a judge.

Warner Bros Discovery drafts break-up plan

Group behind CNN and HBO has discussed options including spin-off of its streaming service and movie studio

Warner Bros Discovery has discussed a dramatic plan to split its digital streaming and studio businesses from its legacy television networks as the US media giant behind CNN and HBO weighs options for boosting its sagging share price.

People familiar with the matter said chief executive David Zaslav was examining several strategic options, ranging from selling assets to hiving off its Warner Bros movie studio and Max streaming service into a new company unburdened by most of the group’s current $39bn net debt load.

WBD, whose market capitalisation has fallen by a third to about $20bn in the past year, has yet to hire an investment bank to initiate any specific transaction, but its top management has been talking to advisers to find a solution in shareholders’ best interest, people briefed on the matter said.

WBD’s biggest backers include cable billionaire John Malone and the Newhouse family, which controls Condé Nast.

People close to WBD have also informally approached advisers to rival media groups to understand if they would be interested in exploring M&A options with some of its existing assets, one person said.

WBD reportedly considered earlier combinations with both Comcast’s NBCUniversal and Paramount, which has since agreed to sell itself David Ellison’s Skydance studio. Both have legacy television assets and subscale streaming platforms.

WBD declined to comment. People familiar with the matter said WBD could still ultimately decide to continue operating as it is currently structured.

A break-up appears to be the strongest option, these people said, and most of its debt could remain with the mature pay-TV networks business in such a scenario. That could help the faster-growing streaming spin-off achieve a higher valuation multiple, but one person familiar with the matter said WBD’s management was aware of the risk of crossing creditors.

Analysts at Bank of America have warned that such a split could have a “potentially devastating” impact on bondholders, and WBD rival Lionsgate recently faced a creditor revolt after separating its Starz pay-TV network. A person involved in the discussions noted that WBD’s debt was raised in a lenient environment with few covenants preventing such financial engineering.

The “strategic spin-off” idea under consideration would create a company made up of WBD’s legacy television assets, which have experienced a decline in revenues despite still generating most of its cash flow. Much of WBD’s heavy debt load would be housed in the TV group, leaving the faster-growing streaming and studio business with fewer borrowings and more flexibility to invest in growth.

The discussions reflect wider concerns about WBD, whose shares have fallen by about 70 per cent since AT&T spun off Warner Bros and it merged with Discovery two years ago. They have been hit by a cratering advertising market, the high costs of developing its streaming offering, the Covid-19 pandemic, Hollywood strikes and some expensive flops.

WBD has slashed costs and paid down debt, but in February the stock dropped 10 per cent after its chief financial officer said he could not give projections for free cash flow this year.

BofA analyst Jessica Reif Ehrlich wrote this week that WBD’s “current composition as a consolidated public company is not working”. It should explore asset sales, restructuring and mergers, she argued, even as she acknowledged that the potential for a creditor backlash to a spin-off meant “the optics are not ideal”.

A split could face other complications, creating two separate companies needing to negotiate terms for sharing sports rights and other content that WBD currently distributes on both digital and traditional television platforms.

Zaslav set off speculation that he might be looking to make a deal in remarks to reporters at last week’s Allen & Company conference in Sun Valley, Idaho.

Asked to comment on the US presidential race, he said: “We just need an opportunity for deregulation, so companies can consolidate and do what we need to be even better.”

Former Segantii employee Robert Gagliardi says SEC does not plan action against him

The former Segantii Capital Management employee whose trading formed part of the US probe into Morgan Stanley that the Wall Street bank settled this year for $249mn has said the Securities and Exchange Commission is not planning to take action against him.

Block trading specialist Robert Gagliardi made the statement in court filings for a breach of contract lawsuit he is bringing against his subsequent employer, hedge fund Evolution Capital Management, which he says owes him a $7.5mn bonus.

Evolution said in filings last month that it believed Gagliardi was the unnamed investor referenced by the SEC and US Department of Justice in January in extracts it cited from documents about their probes into Morgan Stanley’s block trading business.

It said paying a bonus to an employee who had previously engaged in such “disreputable conduct” could bring it into disrepute itself.

Gagliardi said in his latest court filing, dated July 12, that he would “proceed on the assumed basis that those extracts refer to him”, but that Evolution’s inclusion of them in its court filings was “abusive” and part of a “smear campaign”, and that no regulator had ever accused him of wrongdoing.

Alongside Morgan Stanley’s settlement with the SEC, the former head of its US equity syndicate desk Pawan Passi admitted to misconduct for leaking confidential information to investors. The authorities did not name or announce any actions against recipients of the information.

The extracts Evolution selected included one from a DoJ document in which an unnamed investor, which the hedge fund said it believed was Gagliardi, referred to Passi as his “daddy” who had “put [him] in the f*cking game” on block trades. Another extract from the document described an investor betting against Canada Goose after talking to a Morgan Stanley banker who asked, “how is your store of cold weather jackets?”, and “chuckled”.

Other extracts taken from an SEC document described occasions on which a hedge fund investor, which Evolution also said it believed was Gagliardi, bet against clinical services company Medpace and house leasing group Invitation Homes, after talking to Passi ahead of block trades. Block trades are sales of large amounts of a company’s stock, which can depress its share price.

Gagliardi worked at Segantii at the time of the Canada Goose, Medpace and Invitation Homes trades, and at Evolution at the time of the “daddy” comment. Segantii declined to comment.

He said none of the authorities’ documents “makes any allegation of wrongdoing against” the investor or alleges “disreputable conduct” or that the person in question “knowingly used confidential information to obtain any unfair market advantage”.

He said the SEC had “confirmed expressly” in a letter dated March 4 that “on the basis of the matters to date it does not recommend that any action be taken” against him. An SEC spokesperson declined to comment.

The DoJ’s document said the “daddy” comment was an example of how “hedge fund investors who received confidential information . . . about upcoming blocks recognised that this information allowed them to profit in ways they otherwise would not have”.

A spokesperson for Gagliardi said Evolution’s claims were “a desperate attempt to rewrite history after the event, relying on so-called ‘impressions’ to exploit the court process to damage his reputation”, and that he “categorically denies any insinuations of wrongdoing” and “looks forward to responding and robustly defending his position”.

Segantii is now shutting down after Hong Kong’s Securities and Futures Commission in May announced a separate case against it, its founder Simon Sadler and former trader Daniel La Rocca, alleging criminal insider dealing. That case does not involve Gagliardi and relates to trading that took place before he joined the firm. Segantii has said it plans to defend itself “vigorously”. Sadler declined to comment. A representative for La Rocca did not immediately respond to a request for comment.

Gagliardi said in his latest filings that “the Evolution group” also hired La Rocca in 2022, alleging that the firm knew he “was under a regulatory investigation for insider dealing” at the time. La Rocca worked at Evo Capital Management Asia Limited from June to October 2022, in between stints at Segantii, according to the SFC. An Evolution spokesperson said it had no knowledge of the investigation when it hired him.

Gagliardi also said in the filings that Evolution was returning clients’ funds and planned to “cease trading as a hedge fund” after Morgan Stanley dropped it as a client of its prime brokerage business — the often lucrative corner of investment banks that provides services to hedge funds. Morgan Stanley declined to comment.

Instead, Evolution would become a family office for its founder Michael Lerch, Gagliardi said.

Gagliardi’s filings cited an internal email from September 2021 that said Evolution’s US entity traders “cannot trade US PRODUCTS (US swap ok)”.

That email said: “If any prime brokers find out that US traders (under Evolution Capital Management LLC) executed US products and their compliance raise the issue, we will most likely be required to terminate prime brokerage agreement . . . PLEASE PLEASE PLEASE BE CAREFUL.”

A person with knowledge of Evolution’s operations said the email was “taken completely out of context — it is in relation to maintaining routing connectivity”, for example, “that offshore employees route orders through the proper entity”.

Gagliardi said Evolution — which is countersuing him for the $7mn it paid him while he worked there — had decided by 2022 not to pay his bonus, and “events 18 months after that date do not justify such non-payment”.