Can here. Today we talk stocks. And, yes, Uber.
Taking Stock of Stocks
What determines the price of a given stock? If you want to be academic about it, you’d expect it to be net present value of all future expected cash flows to the stockholders. In reality, though, it’s set by supply and demand; a stock price goes up when other people want to buy it. Of course, the stock holders do expect some benefits, so those two theories do say the same thing. This is all Financial Markets 101, and you don’t even need an MBA to know this stuff, as my co-host kindly pointed out.
Anyway, talking about stock prices, the ride share behemoth (Disclaimer: My former employer and I have some stock) Uber went public the last week.
It hasn’t been going particularly well.
DealBook from The New York Times:
Uber suffered the worst first-day dollar loss of any U.S. I.P.O. ever.That’s a terrible start for the biggest market debut in years. What was supposed to be a celebration turned into an exercise in expectations management: “I think we came public on a tough day, and a tough week,” Dara Khosrowshahi, the company’s C.E.O., told Mike Isaac of the NYT.
Let’s be real: It’s a fool’s errand to do any sort of deep dive on a stock that’s a couple days old. And it’s easy to go full Pessimists Archive and sneer at news companies calling it doom and gloom on other tech stocks that didn’t well on its IPO day, only to rise to never-before-seen heights. Amazon this, Facebook that. Again, Intro Corp Finance stuff.
On the other hand, there are certain expectations of a company on its IPO day, and of them is that their stock go up a bit. Not too much, since the spread between the opening price and the eventual price ends up in the underwriters’ pocket instead of the company, but a few points up is good for the soul.
Of course, it’s pointless to judge a company by its IPO. But that doesn’t mean that the stock price is entirely meaningless. This stuff matters to some people! If you were, say, an Uber employee with stock options (or Reserved Stock Units), you’d rather have the stock go up. Maybe your employer doesn’t get much more on the listing day, but you do, or at least feel that way, since you’d be locked up for 6 months. I don’t think there are many people whose options are underwater (and Uber switched to RSUs in late 2014), but either way, higher stock price is good for most people.
Stocks Rule Everything Around Me
I talked here before stock options a bit, since that’s a major part of the compensation packages at tech industry. Both prospective and future employees (and former) follow the stocks of their favorite companies closely. If the stocks go down enough, you can see the recruitment funnel tighten, and the talent attrition go up.
A fair question here is why tech companies favor such equity heavy compensation packages. A satisfyingly folksy answer is that early stage companies with not much revenue but lots of growth potential don’t have much money, so equity is all they have. And, sure, it has the nice side-effect of aligning the interests of The Company with its employees, which should ideally make you work...better? There’s a hint of socialism at play in this arrangement too, if you squint a bit.
Again, I’ve gone on record saying that if you are joining an early stage firm, stock is where you want to be since the profits flow to the capital as opposed to labor in our system. It’s just the smart thing to do. But the origin story of equity have stock packages does sound a bit more financial engineering-y than a rosy, meritocratic system.
Take it from Aswath Damodaran, the towering figure of valuation at NYU Stern: (Emphasis mine)
In particular, accounting rules allowed companies to grant options to employees and show no cost, at the time of the grant, if the options were at the money. Not surprisingly, companies treated as options as free currency and gave away large slices of equity in themselves to employees (and, in particular, to the very top employees), while claiming to be spending no money. If and when the options were exercised later, companies would report a large expense (reflecting the difference between the stock price at the time of the exercise and the exercise price) and show that expense either as an extraordinary expense in the income statement or adjust the book value of equity for it.
After a decade of fighting to preserve this illogical status quo, the accounting rule makers finally came to their senses in 2006 and changed the rules on accounting for option grants. Companies were required to value options, as options, at the time of the grant and expense them at the time (with the standard accounting practice of amortizing or smoothing out softening the blow). This is the law that is triggering the large stock-based employee option expenses at Twitter and other companies like it, that continue to compensate employees with equity. It is worth noting that the change in the accounting law has also resulted in many companies moving away from options to restricted stock (with restrictions on trading for a few years after the grant), since there is no earnings benefit associated with the use of options any more.
Valuation is hard, and even seasoned professionals make mistakes all the time. And while the financial facade of numbers and jargons lend the industry an aura of objectivity, the reality is quite different. There are issues around integrity (people lie), motives (some people want high prices, some people low) and then competence (well, people suck).
Let’s say you magically were able to account for all that. Still doesn’t help. Many highly educated people who have studied at a small number of schools (which itself is a problem), and learned the material from even fewer number of canonical sources differ in their analysis.
And then there is the issue of comparison. Different companies describe similar businesses in different ways, which makes comparisons extremely hard. This gets exponentially harder when not just the companies themselves are new, but also their industries. As a fresh-faced almost MBA grad, I read the Uber and Lyft S-1 documents couple times over, and my head was spinning.
Turns out I wasn’t alone, even people whose jobs are reporting on stuff is confused:
A knee-jerk reaction to such dizzying complexity is that these companies are hiding behind this complexity, but I am not convinced. This ride-hailing stuff is quite new as a business, and there are no real precedents to some of the key metrics. We went through such adjustment periods when social media companies were growing up too. Eyeballs made way to Daily and Monthly Actives, vanity figures like cumulative user numbers to more business relevant ones such as Average Revenue Per User. As Uber and Lyft mature, they will better at telling their stories. Markets, in their infinite wisdom (one hopes?) will figure out what metrics really matter.
But, the key question remains: When there are tons of people who constantly get it wrong, what are you supposed to do as an individual tech employee to value your stock?
Show Me the Money
A good way to think here is how your compensation package is set. Similar to the stock price discussion above, one way is to anchor it on how much you make for the firm. It can’t pay you the exact amount of value you add, then the firm would make no money. It also clearly can’t you pay you more, since then why would the firm hire you? So, you end up making just a bit under what you make for the firm.
But of course, in reality, in tech and other relatively liquid labor markets, companies end up paying to most people enough to keep them employed here rather than there. If you are an efficient markets person, like I am, the ultimate way to price those options would be to get as many offers as possible, and see the point they converge to for your private stock options.
This isn't really ideal, since different companies will judge you differently (a self-driving expert is worth more to Google than she is worth to Netflix, but an UI engineer could make more at Facebook than at either) but it’s one way. If you are particularly enterprising, you can peruse the H1-B salaries or find someone with access to Option Impact or one of those storied salary databases. Or, of course, you could just move to in Norway or Sweden, where such data is more publicly available. That does sound like cheating though.
Stock based compensation is here to stay, whether anyone likes it or not. And this stuff is not always pleasant, watching your net worth tumble down as Jim Cramer goes on screaming on CNBC. Just ask LinkedIn employees how they felt before Microsoft acquisition closed.
The rapid devaluation has posed more than just a problem for investors. LinkedIn’s employees are paid largely in stock, and therein lies the rub: Around the company’s new 26-story skyscraper that opened in downtown San Francisco in March, as well as the corporate headquarters in Mountain View, Calif., there have been persistent whispers about whether LinkedIn could retain its top talent as the marketplace clobbered their incomes.
I’ve argued before the situation is not ideal, and industry should change its terms to give earlier employees a more realistic chance at building wealth. Before that happens though, employees should do their best to evaluate their portfolio for the long horizon, avoid short term rash decisions, and most importantly diversify their holdings. Seriously, this stuff is so easy you could even fit on an index card.
There are established financial dynamics to IPOs in general, but what captures the attention is the human aspect. Every big IPO is fodder for some drama, and this being the Uber IPO, it’d be amiss if something wasn’t out of the ordinary, unexpected, and utterly polarizing. The plummeting stock price is what stole the show this time.
Now, ask yourself: would the same people who are claiming that such a dramatic drop is actually good be saying the opposite if the price went up?
I have my guesses. Now, if you’ll allow me, I’m going to look at some stock tickers...
What I’m Reading
The dangerous world of being paid in shares: How tech firms' massive rewards are coming back to bite them: Well, this is fitting. Alex Stamos, the former Facebook Chief Security Officer and others argue that tech stocks cause employees to outsource their morality to Wall Street, which I guess is not as good as Silicon Valley. The piece is behind a paywall, but you can login to read it:
[Alex Stamos:]"Markets have demonstrated that they don't care about social responsibility – they only care about what the quarterly numbers look like and what guidance they are given on future revenues... it's incongruous with our beliefs about changing the world in a positive way that we're inheriting the lower Manhattan school, or the City of London school, of what makes a responsible company. There's more to responsibility than returning value to shareholders."
Chris Eberle, a former director at Facebook who gave out and received many "secret taps on the shoulder", agrees. "When you're incentivised through stock grants, everything becomes about what's important to Wall Street," he says. At Facebook, that led employees to "not look too closely" at anything that might diminish Facebook's most important numbers, such as user growth and engagement.
When Bitcoin Grows Up: Seems like a million years ago now, from the madness of 2017. But Bitcoin is up again, for better or worse. A good time to re-read this piece by John Lanchester in London Review of Books. Just the story of how the founder of Silk Road got caught is worth reading the entire thing in full:
On 1 October 2013 Ulbricht was sitting in a public library in San Francisco, logged into Silk Road via the library’s wifi. He was in an online chat with an FBI agent whose job was to make sure Ulbricht was still online when his colleagues swooped. Ulbricht was at a desk across from a slight young Asian woman when a couple of typical San Francisco street people began arguing loudly just behind him. He turned to look, and the young woman grabbed his laptop: she was an FBI agent. So were the street people. Nice one, the Feds. Ulbricht was logged into Silk Road under the account ‘/Mastermind’. Game over for Dread Pirate Roberts. Ulbricht went on trial in 2015, was convicted, and is serving two life sentences without the possibility of parole.