DealBook: Should Google Shrink to Save Itself?
Google reportedly weighs divesting a big ad business
As antitrust regulators turn up the heat, the company is reportedly considering a sale or spinoff of its third-party ad tech unit, Keach Hagey and Rob Copeland of the WSJ report, citing unnamed sources.
The context:
• The Justice Department has increasingly focused on Google’s third-party ad business, which was “built largely on the company’s 2008 acquisition of the ad-technology firm DoubleClick,” Ms. Hagey and Mr. Copeland write.
• Google’s ad-tech business consists of software used to buy and sell ads across the web.
• Critics say Google unfairly bundles these tools together and uses them to help its own services, like search and YouTube.
Some Google executives have discussed informally “whether the company should consider divesting its third-party ad tech business, according to people familiar with the situation,” Ms. Hagey and Mr. Copeland write. (A Google spokeswoman said there were no plans to divest the unit.)
Proponents of divesting the business note that the ad tech arm “has steadily declined in importance to Google overall since the DoubleClick purchase, while units like search and YouTube have soared.” That’s because web search traffic is stagnant, while mobile internet use is booming.
“For Google, a partial voluntary breakup of its advertising business might be preferable to whatever regulators come up with on their own,” Alex Webb of Bloomberg Opinion writes.
Early premarket gappers
- Gapping up:
- RAMP +8.9%, ELF +8.8%, SONO +8.7%, ARWR +7.5%, USX +7.5%, QNST +6.2%, IRBT +5.9%, NGL +4.9%, GLUU +4.8%, ACLS +4.6%, CSGS +4%, TTMI +3.3%, ENSG +3.3%, LDOS +3.2%, FOXA +3.2%, ECHO +3.2%, SNY +3.2%, SAVE +3.1%, TGI +2.7%, BCEL +2.4%, ZNGA +2.4%, COHR +2.3%, MC +2.3%, LNC +2.2%, ING +2.2%, RDN +2.1%, LL +1.8%, JJSF +1.7%, CTSH +1.6%, CUZ +1.5%, VLRS +1.3%, GDX +1.2%, REGN +1.2%, FORM +1.1%, NRZ +1.1%
- Gapping down:
- FNKO -38.8%, ENS -12.8%, CDAY -12.2%, MTRX -11.8%, GPRO -11.5%, UHAL -9%, PTON -8.4%, AGTC -7.1%, NTGR -7.1%, ANGI -6.5%, TWLO -5.6%, TWO -5.3%, FEYE -4.4%, PAYC -4.4%, BLL -3.7%, QCOM -2.6%, YUMC -2.1%, ACB -1.9%, LCI -1.5%, MXL -1.4%, ICHR -1.1%, NUAN -1.1%, GRUB -0.8%, CCMP -0.8%
>>> Up
* Melexis PT Raised to 85 euros from 74 euros at Liberum
* Novo Nordisk PT Raised to 500 kroner at Intron Health
* OTP Bank Raised to Buy at VTB Capital; PT 17,400 forint
* WDP Raised to Buy at KBC Securities (+)
>>> Down
* CMC Markets Cut to Add at Peel Hunt
* Griffin Mining Cut to Sell at Panmure Gordon; PT 47 pence
* Hexagon Cut to Hold at ABG; PT 560 kronor
* Indutrade Cut to Sell at ABG; PT 305 kronor
* Ingenico Group Cut to Hold at Berenberg
* JLEN LN Cut to Underperform at Jefferies
* Outokumpu Oyj Cut to Neutral at Goldman (+)
* SIG Combibloc Cut to Hold at MainFirst; PT 16 Swiss francs
>>> Initiation
* Hapag-Lloyd Rated New Underweight at JPMorgan; PT 36.41 euros
* Mithra Pharma Rated New Buy at Berenberg; PT 40 euros
>>> Call
* ABI’s Almeida Could Be a Candidate for CEO Succession: Jefferies (+)
* ArcelorMittal Shares Should Outperform on Solid Results, MS Says (+)
* Ashmore 1H a Pretax Beat But of Mixed Quality: Morgan Stanley (+)
* Beazley Shares to React Positively to Strong Update, MS Says (+)
* Compass 1Q Sales Show Slowdown, But Still Ahead of Peers: MS (+)
* Daetwyler Dividend Disappoints, Outlook ‘Uninspiring:’ Baader (+)
* Equinor 4Q Likely to Get a Positive Reception: Handelsbanken (+)
* Klepierre Results In Line; Citi Keeps Structural Headwind View
* Mithra Pharma Given Street-High PT as Berenberg Initiates at Buy
* Nokia Shares Seen Gaining by Handelsbanken After ‘Solid’ Quarter
* OMV 4Q Challenging But Dividend Increase Positive, Citi Says (+)
* Publicis Results In-Line, North America ‘Encouraging:’ Berenberg (+)
* SIG Combibloc Cut at Mainfirst on Limited Short-Term Upside (+)
* SocGen Earnings Solid, Beats on Stronger CIB: Goldman Sachs (+)
* UniCredit Delivers Good News, Shares Expected to Rise: KBW (+)
A little ETF rule change that could make a big difference
It’s been a while since we looked at the behind-the-scenes mechanics of ETFs, or how market-making and algo-assisted arbitrage in the industry influences price action in stocks and indices more widely.
One big development in recent months has been the SEC’s new ETF rule, which came into effect on December 23, 2019. It was designed to lower barriers to entry into the sector and stimulate more competition.
The rule did get a fair bit of attention when it was first announced in September 2019, not least because it was supported by the US regulator’s notorious innovation champion Hester Peirce -- also dubbed “cryptomum” because of her support for cryptocurrency ETFs. But some important details -- notably how the rules will impact the industry practice of using customised baskets for creation and redemption -- probably failed to get the attention they deserved.
So what’s a customised basket anyway?
In the early days of ETFs -- before the universe was hugely expanded by the introduction of more and more niche index products, synthetics and active offerings -- the basic mechanics of how the system was managed were pretty simple.
ETFs tracked indices. To manage that tracking, they depended on a market-based arbitrage mechanism to regulate supply and demand of ETF units relative to the price of the underlying constituents of the indices they tracked. If the price of an ETF unit was trading at a premium or discount relative to the indicative value of its underlying constituents, a dedicated ETF market-maker (known as an authorised participant or AP) could exploit that mis-pricing until the two values were brought back into line with each other.
When ETF units trade at a premium to the so-called indicative net asset value (iNAV), APs have an incentive to buy the constituent stocks that make up a creation basket so they can receive ETF units. They can then sell these at a premium to the market capturing a spread. Such activity is known as creation and expands overall fund holdings as well as shares outstanding.
When ETF units trade at a discount to the iNAV, APs have the opposite incentive. They deliver ETF units to the manager in exchange for discounted holdings which they can then sell in the market at normal prices, capturing that differential for themselves instead. Such activity is known as redemption and it reduces overall fund holdings as well as shares outstanding.
All of which is simple enough.
Except, the reality on the ground was never that simple. Practitioners soon realised the above was an idealised process. While it was desirable in terms of risk management to faithfully replicate index weighings in baskets, in practice doing so didn’t account for the day-to-day frictions which could inhibit the smooth running of the creation and redemption and thus inhibit good ETF tracking.
One such friction was the variance in the availability of the underlying constituents and the potential difficulty in forging perfectly weighted baskets for delivery at short notice. This led many ETF managers to allow APs to deliver customised baskets, effectively permitting stocks to be delivered in weightings that suited APs rather than shareholders. In some cases, hard-to-find stocks or bonds were even allowed to be substituted with cash outright or other collateral (increasing the risk of index-tracking error even further).
The regulatory approach to this sort of customisation, however, was never consistent. As the SEC notes, in the early days of ETFs there were few explicit restrictions on basket composition. From 2006 onwards, however, the SEC began to place much tighter restrictions on baskets, requiring they generally correspond pro rata to the advertised portfolio holdings, allowing only limited circumstances in which ETFs could use non-pro rata baskets by way of applied exemptions.
As the SEC noted in its September ruling, the logic for discouraging customisation relates to the risk that APs could take advantage of their relationships with ETF managers to pressure them to construct baskets that favoured them -- to the detriment of ETF shareholders or the fund’s tracking objectives. The further fear was the system would encourage dumping of less liquid securities in creations, and the cherry-picking of more liquid ones in redemptions. The regulator also worried it could introduce a general liquidity mismatch risk to portfolios (our emphasis):
For example, because ETFs rely on authorized participants to maintain the secondary market by promoting an effective arbitrage mechanism, an authorized participant holding less liquid or less desirable securities potentially could pressure an ETF into accepting those securities in its basket in exchange for liquid ETF shares (i.e., dumping). An authorized participant also could pressure the ETF into including in its basket certain desirable securities in exchange for ETF shares tendered for redemption (i.e., cherry-picking). In either case, the ETF’s other investors would be disadvantaged and would be left holding shares of an ETF with a less liquid or less desirable portfolio of securities.
With respect to cash substitution the other risk was also that:
... during periods of market stress, an authorized participant may demand cash from the ETF instead of less liquid securities in exchange for ETF shares, impacting the liquidity of the ETF’s portfolio and the ability of the ETF to satisfy additional cash redemption requests from authorized participants
But the flip side of the argument was that discouraging customisation only added expenses and costs. ETFs without basket flexibility would typically require a greater number of individual securities within their baskets. This, the SEC noted, could lead to wider bid-ask spreads and potentially less arbitrage, creating a situation where ETFs with pro-rata basket rules would be competitively disadvantaged against those with more flexibility on composition. The disadvantage might then encourage them to turn to exemptions that allowed them to substitute for cash collateral, which the SEC worried would result in “cash drag” on ETFs’ performance and increase tax exposures.
Given the above, the SEC’s new rule aims to level the playing field by making basket customisation far easier for all ETFs. But -- in a bid to keep bad behaviour in check -- there’s a proviso that those who engage in custom baskets must adopt a formal policy or procedure governing their construction. They must also keep internal records, while appointing specific employees with the responsibility of ensuring custom baskets comply with the formalised policies. This is no doubt to prevent APs from exploiting the process by demanding overly bespoke adjustments that favour them over shareholders and other APs.
And yet, bizarrely, the SEC has stopped short of demanding public disclosure of what customised baskets end up being. This means it will still be very hard for the market at large to track or understand the potential correlation risk being introduced into portfolio holdings because of basket customisation.
The SEC had originally intended (and we think rightly so) to require ETFs to post information about such baskets on their websites each day so as to “facilitate arbitrage by providing APs and other market participants with timely information regarding the contents of a basket that the ETF will accept each day”. Also, to “allow market participants that do not have access to an ETF’s daily portfolio composition file (PCF) to compare the ETF’s basket with its portfolio holdings, assist in building intraday hedges, and estimate the cash balancing amount”. Both are strong arguments for disclosure.
In overturning the proposal it does lead us to wonder whose interests the SEC really ended up representing?
To support its non-disclosure reversal, the SEC cited a range of counter-arguments from industry commenters, ranging from the weak assertion that enforcing disclosure would be “irrelevant for secondary market investors”, to the idea it would risk confusion “particularly if the basket is mistaken for portfolio holding information”. The other contention was that public disclosure could “delay the process by which the ETF and an AP negotiate the contents of a custom creation or redemption basket” and that the basket composition information could be accessed through the National Securities Clearing Corporation (NSCC), an intermediary or the ETF itself.
But the real motivation for dropping the disclosure requirement probably related to the industry panicking that the act of forcing ETFs to publish basket compositions before accepting orders for creations or redemptions could, as the SEC put it:
... raise the risk that market participants front-run trades in basket securities or attempt to replicate authorized participants’ or other market makers’ trading strategies, particularly for those ETFs that have more frequent primary market transactions.
This is undoubtedly a real risk. But it’s also true that publicly publishing basket information was always going to disrupt the clear and obvious trading advantage afforded to market participants who have privileged access to PCF files in any shape or form at all.
What’s more, arguing the information can be easily obtained from other sources such as the NSCC or from ETFs directly hardly solves the transparency problem, since the sort of people likely to scrutinise the data for correlation or liquidity risk (retail investors, journalists and market-watchers) would still probably not have access.
As investment-research company Morningstar noted in its own comment to the SEC:
We believe that transparency around baskets is critical for investors. We understand that ETF sponsors need the flexibility to deviate from pro rata baskets. As such, all baskets that were utilized in a day should be disclosed, at a minimum, by the end of the day. Such disclosure would allow analysis of whether the baskets are facilitating appropriate market making and liquidity, particularly during times of market stress. We also believe that other information, such as whether the fund faces any impediments to creating new units and whether it is pending closure, should be disclosed on any day that this information is applicable.
And that really is the key point. Unless PCF information is made publicly available -- at a minimum -- on an end-of-day basis, those actors with privileged access to it will always get advanced insight into potential tracking-error risk and other impediments arising in the creation/redemption process.
And so we find ourselves in a situation where the SEC’s new rule will allow APs and ETF managers to mess around with deliverable/redeemable basket compositions like never before. And yet, the chances of analysts or media spotting any potential correlation, tracking or liquidity mismatch issues that arise from this freedom to deviate are more than slim, because none of that data is any easier to obtain by the public.
If any readers do have access to the PCF files of any prominent US ETFs, it would be great to see what impact the rule is already having, if any. Please do share!
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- Total 4Q Adj. Net Income Beats Estimates at $3.17B
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- SocGen Earnings Solid, Beats on Stronger CIB: Goldman Sachs
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ING (INN1 TH) -0.9%
- ING Compliance Costs Hit Earnings Despite Surprise Lending Gain
DAX:
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- Nike, Adidas, Michael Kors Owner Warn on China Hit: Virus Impact
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MDAX:
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SDAX:
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- Shares fell 4.5% yesterday
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Iran hardliners try to shape radical new parliament
Veteran MP disqualified from participation in parliamentary polls
The son of a cleric whose teachings helped shape the Islamic republic, Ali Motahari, 62, has for more than a decade been a member of parliament and a leading figure in the Iranian political establishment.
But even these impeccable revolutionary credentials failed to prevent his disqualification from participation in this month’s Iranian parliamentary elections. More than 90 sitting MPs, including conservatives and hundreds of reformist candidates, have been told they cannot contest the polls.
Emboldened by the public outpouring of grief for military commander Qassem Soleimani, killed in a targeted US air strike last month, hardliners see the February 21 parliamentary poll as a chance to forge a radical new assembly.
The Guardian Council, the hardline constitutional watchdog that vets prospective candidates, has questioned many candidates’ “allegiance” to Islam and the Islamic republic and, in some cases, accused them of financial fraud.
“I am worried for the future of the Islamic revolution with this approach of the Guardian Council, which will further restrict freedom of speech and people’s role in determining their destiny,” said Mr Motahhari, who has previously voiced support for reformists.
“When a member of the council told me that I had to repeat what they say, I shivered.” He quoted a promise made by his father, Morteza Motahhari, during the 1979 Islamic revolution that communists and “non-Islamic parties can enjoy freedom of speech provided they do not attribute their comments to Islam”.
In the two years since president Donald Trump pulled the US out of the 2015 nuclear agreement — the signature achievement of Iran’s pro-reform forces — and imposed tough economic sanctions, hardliners have pushed a more radical agenda.
They have jumped on the anti-US mood in the wake of Soleimani’s death last month to block reformist candidates who they say lack the courage to stand up to Washington and foolishly agreed to the nuclear deal in the first place. “The US pressure is so terrifying and unprecedented that Iran’s radicalisation has become a natural and predictable result. The US’s role has always been detrimental to Iran’s move toward democracy,” said Saeed Laylaz, a reformist analyst.
“All political factors indicate that Iran is moving towards a unanimous, authoritarian system,” said Mohammad Atrianfar, a political activist.
While Iran’s 290-member parliament usually bows to the state’s wishes, it does in theory have the power to monitor the executive and can impeach members of the government, including centrist president Hassan Rouhani.
Iran has always operated a strict vetting system for both parliamentary and presidential polls. Candidates must be aged between 30 and 75, have a masters degree, and show loyalty to Islam and the Islamic republic. Once they have passed initial scrutiny by the ministry of interior, their applications are sent to the Guardian Council.
But so severe has the disqualification process been that hardline candidates face no serious competition from reformists for about 200 out of 290 seats, reformists said. About a third of sitting members of parliament have been disqualified from standing again. In smaller constituencies that have traditionally had a high turnout that might favour a reformist or pro-reform candidate, reformists have been disqualified.
“The qualification system is so carefully engineered,” said a reformist member of parliament who decided not to run again because he feared he wouldn’t meet the strict criteria. “In constituencies where reformists have a chance of winning, they are disqualified and wherever there is no chance of winning they have qualified.”
The disqualifications also speak to the weakness of reform movement in Iran, whose core policies include rapprochement with the west and more liberal political and social policies within the Islamic republic’s system. Reformists’ numbers have been decimated by repression. There is not a strong opposition overseas and no one is presenting a viable alternative to the Islamic republic, analysts said.
While some politicians have called for the polls to be boycotted, many want to promote the few reformist candidates there are and encourage people to vote. Still, Mohammad-Ali Abtahi, a former reformist vice-president, said there was a future for the reformist movement. “Reformists can have a louder voice when they are outside the official establishment,” he said. “And people will come back to reformists after they hear radicals’ voices every day.”
The hardliners are overplaying their hand, Mr Atrianfar said, warning that public demands for change will not disappear. “The Iranian society will force hardliners to address their calls for reforms. The guards cannot make decisions in garrisons.”
Such is the outcry over the disqualifications that Iran’s supreme leader Ayatollah Ali Khamenei was expected to use his “absolute authority” allowed under the constitution to let some of the more prominent disqualified candidates run. However, on Wednesday Mr Khamenei showed no signs of intervening, saying the next parliament would have no place for those who were scared of speaking out against foreign enemies.
He warned against disappointing voters by claims that the elections’ results were pre-determined and called on people to vote for nationalistic reasons even if they disliked him.
For now, even as reformists recognise defeat is likely, they want the chance to compete. “In their private circles, they [hardliners] say ‘the next parliament is 100 per cent ours’. If so, at least let some competition take place,” the centrist Mr Rouhani said. “We don’t mind if the [next] parliament is going to be all yours. Bon appétit!”
Publicis hit by client losses and US restructuring
Advertising group’s chief warns that Accenture is becoming ‘major competitor’
Advertising company Publicis was hit by a fourth-quarter slowdown because of client losses and restructuring in the US.
It capped a difficult year as chief executive Arthur Sadoun seeks to reshape the company to cope with technological disruption and new competitors like consulting giant Accenture.
The world’s third-biggest ad group by sales on Thursday posted a 4.5 per cent decline in organic sales in the fourth quarter, on revenue of €2.9bn. This was slightly better than analysts’ expectations, according to a company-compiled consensus, and took the annual organic sales decline to 2.3 per cent.
That key metric, which strips out currency effects as well as acquisitions and disposals, is tracked closely by investors and used to compare the performances of the various ad groups.
“The magnitude of change at Publicis in the last year has been great and this hurt our performance,” Mr Sadoun said in an interview. “But now our transformation, in terms of structure and assets, is complete, and our recent new business wins show we are on the right track.”
Net profit grew by 9.8 per cent to reach €1.2bn last year, driven by an improved operating margin of 17.3 per cent. Earnings per share for the year reached €5.02.
The company also confirmed an earlier target for 2020 organic sales growth to come in somewhere between a 2 per cent decline and a 1 per cent increase.
Publicis, which competes with larger rivals WPP and Omnicom, is betting that its $4.4bn acquisition last year of Epsilon, a digital marketing agency that owns a trove of online and offline data on consumers, will help it better serve its big clients from consumer goods makers to banks.
But investors still appear concerned that execution problems, management upheaval, and repeated restructuring plans at Publicis are not over.
Its shares have fallen nearly 30 per cent in the past year after it twice scaled back its growth guidance. WPP shares rose 10 per cent in the same period, while Omnicom shares were largely flat.
It remains to be seen whether any of the big ad groups has figured out how to cope as Facebook and Google siphon off more ad dollars, and big advertisers like Procter & Gamble and Unilever increasingly do more work in-house.
Another concern among investors has been Accenture’s aggressive expansion into digital marketing in the past five years via acquisitions, the hiring of top talent and organic growth.
The consulting giant has built a business that brought in more than $10bn in annual revenue in Accenture’s financial year 2019; that compares to nearly $15bn annual sales for Omnicom and $12bn for Publicis.
Mr Sadoun said Accenture’s recent decision to stop doing so-called “media audits” for advertisers to verify where marketing messages were placed was a shot across the bows for traditional agencies because it cleared the path for the consultancy to expand its “media buying” business.
That service — by which agencies place ads across the web, on TV and on radio on behalf of clients — is a major generator of profits for Publicis and others.
“The choice they made is to go more frontally in our markets,” Mr Sadoun explained. “Given that the market cap of Accenture is bigger than all the agency holding companies together, you realise that this will be a major competitor.”
Nevertheless, the business model chosen by Publicis — namely to have creative, technology and data all housed under one roof — should help it resist Accenture’s competition. “An end-to-end model is the future of our industry,” Mr Sadoun said.