Jun 9, 2019

Axios Capital

By Felix Salmon
Felix Salmon

Situational awareness: United Technologies wants to merge with Raytheon. Microsoft is, as of the close of trade on Friday, the only company in the world worth more than $1 trillion. The 5% tariff on all Mexican imports is not going to happen. And Chrysler parent FCA is not going to merge with Renault after all. Thanks to everybody who replied last week to point out that Chevrolet is a GM brand, not a Chrysler brand. Keep those emails coming!

  • In this week's newsletter: Fed predictability, falling mortgage rates, celebrity monetization, Champagne as a Giffen good, VCs' preferred stock, Chewy goes public, and more, all in 2000 words.
  • "Axios on HBO" is back tonight at 6pm. I have a cameo this week: The cameras caught me talking to the great Alexi McCammond about what Americans think of socialism.
1 big thing: The end of Fed predictability

Illustration: Sarah Grillo/Axios

“I guess I should warn you, if I turn out to be particularly clear, you’ve probably misunderstood what I said.”
— Former Fed chair Alan Greenspan

Jay Powell doesn't know what he's going to do with interest rates. He probably hasn't made up his mind about what he's going to do at the next meeting, which starts on June 18, and he certainly doesn't know what he's going to do on July 31 or September 18 or October 30.

  • Markets are pricing in significant rate cuts in the second half of this year. The consensus seems to be that the cuts will start in September, probably with a 50bp decrease, but there's no great confidence in that forecast.

The uncertainty is deliberate on the part of the Fed. Depending on how you look at it, it's either a relatively new development or rather old-fashioned.

  • Context: Powell and his colleagues could easily signal an expected future path for interest rates if they wanted to. In late 2011, then-chair Ben Bernanke introduced the "dot plot" as a way to communicate even more clearly just how long he expected to keep rates at zero. In general, the Fed has become more transparent and predictable over time, issuing longer statements and being more explicit about interest-rate policy.
  • What they're saying: Powell and his colleagues regularly stress "data dependence" in monetary policy and are increasingly vocal about their distaste for the dot plot. They're honest about the fact that they don't know where the economy is headed; they don't know what unemployment rate constitutes full employment; and they don't know where interest rates must be, over the long term, to ensure price stability.

After the crisis, the role of the Fed was clear: to rescue the economy and prevent it from imploding. Today, policymakers need to decide whether they should cut rates as a form of recession insurance, and whether they should frame any rate cut as a one-off or as the first of a series. They need to determine how much attention to pay to markets, which will throw a tantrum if the expected rate cuts don't materialize — and also how much attention to pay to politics, in a world where Fed policy has become politicized to an unprecedented degree.

The bottom line: We're not going to go back to the world of the early 1990s, when the Fed wouldn't even say what level of Fed funds it was targeting. But in an uncertain world, expect Powell to continue to embrace constructive ambiguity.

Bonus: Check out those mortgage rates
Expand chart
Data: Black Knight; Chart: Axios Visuals

The drop in bond yields has meant a similar drop in mortgage rates. The average 30-year mortgage is now 3.82%, which means there are millions of Americans who could save real money by refinancing their mortgage.

  • By the numbers: 6,827,000 Americans could save at least 75bp (that's 0.75 percentage points) on their mortgages if they refinanced today, according to mortgage analytics company Black Knight. The average principal and interest payment would be reduced by $268 per month. That works out to $1.8 billion per month in total potential savings.
  • The number of homeowners who could save by refinancing has spiked by 3 million in just the past 2 months.
2. Monetizing celebrity

Illustration: Aïda Amer/Axios

One set of retailers is doing a great job of bucking the retailpocalypse trend: famous people. A few examples:

  • Rihanna, having already launched a lingerie line and a hugely successful makeup brand, has now joined LVMH, where Fenty has become a fully fledged international fashion house. Its products, including $460 antisocial sunglasses, are available only online.
  • Kylie Jenner is reportedly a billionaire. Other celebrities, including Gwyneth Paltrow (Goop), Kate Hudson (Fabletics) and Jessica Alba (Honest) are also having more financial success in retail than they ever did in Hollywood.
  • Shopify, a platform that makes it easy for influencers and celebrities to sell goods directly from Instagram, has doubled its share price in 2019 so far. It is now worth more than $30 billion.
  • Cameo, a startup that gives boldface names the opportunity to sell personalized videos to fans, is raising a new round of financing at a $300 million valuation, per Axios' Dan Primack.
  • Techstyle Fashion Group, which is behind both Fabletics and Savage X Fenty, has raised more than $415 million in equity capital, per PitchBook. It describes itself as "a platform to build high-value global fashion brands."
  • Authentic Brands Group recently bought Sports Illustrated magazine for $110 million; it already owns brands under celebrity names from Marilyn Monroe and Elvis Presley to Greg Norman and Shaquille O'Neal.

What we're seeing: If you want your retail store to be swarmed, it helps to be a YouTube influencer. A pop-up shop for David Dobrik's hoodie-centric Clickbait brand attracted 10,000 fans in a single weekend.

  • More established retailers like Nordstrom have teamed up with influencers like Gal Meets Glam's Julia Engel to drive traffic and sales.

Why now? Because reaching and influencing consumers through social media is extremely expensive — unless you're a celebrity with "organic social" reach.

The bottom line: Abercrombie & Fitch is closing flagship stores because they do a dreadful job of driving online sales. Meanwhile, the reverse syndrome — online influencers driving in-store sales — is only getting started. After you add in direct sales from Instagram, being famous has never been more lucrative.

3. Jay-Z meets Sir Robert Giffen

Illustration: Sarah Grillo/Axios

This ain't no tall order, this is nothin' to me/Difficult takes a day, impossible takes a week/I do this in my sleep/I sold kilos of coke, I'm guessin' I can sell CD's/I'm not a businessman; I'm a business, man!
Jay-Z

Jay-Z is a billionaire, according to what Forbes characterizes as a conservative accounting of the recording artist's fortune. Separately, the magazine estimates that his wife Beyoncé is worth another $400 million.

  • His music created a lot of seed capital, some $500 million in pretax earnings. He then invested that capital into creating brands, including the clothing line Rocawear and the music-streaming service Tidal.
  • Jay-Z's biggest brand of all: Ace of Spades Champagne, valued by Forbes at $310 million.

Jay-Z helped to reinvent high-end Champagne. Armand de Brignac Champagne once belonged in the domain of wine snobs, but when it became known as Ace of Spades, it became a true Giffen good: an ostentatious wealth-signaling mechanism where desirability — and demand — increases with price. Ace of Spades is far more popular at $750 a bottle than it was when it was called Cattier and cost $60.

How it works: In a nightclub, no one cares about the difference between the Vallée de la Marne and the Côte des Blancs. What matters is swagger, glamor and instantly recognizable branding. If you can create that, you effectively own a license to print money.

4. Why do VCs get preferred stock?

"Secrets of Sand Hill Road" is the new book from Andreessen Horowitz venture capitalist Scott Kupor, blurbed by former Google CEO Eric Schmidt as being "the definitive book on navigating VC."

  • The capital that VCs provide is no longer scarce, says Kupor. It's entrepreneurs who deserve the real credit for building successful companies, not the people who staked them. And yet, he explains, VCs nearly always receive preferred stock, which gives them many more economic and governance rights than the firm's founders or employees.

What they’re saying: Kupor walks his reader through a typical term sheet where a group of VCs is taking a 20% stake in a startup company for $10 million. The lead investor, with about a 10% stake, will control a majority of the preferred stock. Pretty standard "protective provisions," explains Kupor, mean that the VC investor will "get to vote on" new classes of stock, "have a say in" certain corporate actions and recapitalizations, and "be able to weigh in on" changes to the employee option pool.

  • What they’re not saying: Kupor neglects to mention that these provisions don't just give the preferred shareholder a vote or a seat at the table; rather, they give the VC unilateral veto power over all such actions. It's not clear why a 10% shareholder should be so powerful, especially given that the ability to fund the company is much less rare than it used to be.
  • I asked Kupor about this, and he said that he was open to the idea of VCs taking common stock instead of preferred stock — on the understanding that valuations would be lower, as a result. That seems like a good idea to me, in a world of unicorns where no one is complaining about valuations being too low.

My thought bubble: Investing in common stock is certainly risky. In a worst-case scenario, the founders could just liquidate the company immediately, take 80% of the $10 million for themselves, and give just $2 million back to the VCs. But VC is a risky business. If VCs don't have a basic level of trust in founders, they shouldn't be backing those businesses in the first place.

5. Chewy goes public

Illustration: Sarah Grillo/Axios

Chewy is going public this week, carrying a valuation of about $7 billion, roughly twice what the company sold for in 2017. It too has a special class of shares. Its largest shareholder, BC Partners, will control 98.8% of the votes after the offering is over.

  • Chewy has never turned a profit, and it burned through $63.3 million of cash in the quarter ending on May 5. At that rate, the $101 million it plans to raise in the IPO will last just 21 weeks.
  • After 13 weeks, BC Partners will be free to sell the rest of its Chewy shares, after unloading shares worth $650 million at the IPO. The private equity shop could reduce its stake to as low as 10% while still retaining control of the company.
  • Chewy's super-voting shares aren't held by visionary founders with a long-term time horizon. Rather, they're held by a private-equity shop with a fiduciary obligation to liquidate its holdings and return the maximum amount of cash to its investors.

The bottom line: Chewy's parent, PetSmart, has more than $8 billion of debt and is under enormous pressure to pay it down. It's therefore reasonable to expect large future sales of Chewy stock. What's less clear is how Chewy can continue to invest in growth without raising substantial debt of its own. Per Chewy's revised S-1, the company has already lined up a $300 million credit line.

Flashback: The degraded stock market through the eyes of a pet food IPO

6. The week ahead: Chinese trade data revealed

Illustration: Rebecca Zisser/Axios

A slew of Chinese economic data comes out this week, writes Axios' Courtenay Brown, including trade data tomorrow and retail sales on Friday. Economists will be looking for signs of trade war impact and general weakening of the country’s economy.

In the U.K., the election process to narrow down the many candidates vying to replace Theresa May begins on Thursday. Conservative lawmakers will vote on candidates, who are required to win 5% of votes to advance to a second ballot.

In the U.S., more jobs data is coming tomorrow: The JOLTS survey will shed some insight on just how much demand there is for workers in a tight labor market.

  • Chewy will price its IPO on Thursday and begin trading on the New York Stock Exchange the following day. Cybersecurity company CrowdStrike, which has already boosted the top end of its pricing range, is expected to begin trading on the Nasdaq on Wednesday.
7. Building of the week: Children's Advocacy Center

Photo: Tigerman McCurry Architects

Stanley Tigerman died this week at the age of 88. Described by the Chicago Tribune as "the most influential Chicago architect of his generation," Tigerman spent his career thinking, talking and writing about the ways that architecture can improve the world.

  • Tigerman built Chicago's Woodlawn Gardens, a low-income housing project, in the 1960s. He also created the Pacific Garden Mission, built a headquarters for the Anti-Cruelty Society, and designed both the Illinois Holocaust Museum and the Illinois Regional Library for the Blind and Physically Handicapped.
  • The Children's Advocacy Center of Chicago was built in 2002 to provide "education, support groups, social and child life services, mental health resources, crisis intervention, and court accompaniments" for survivors of child sexual abuse.
Felix Salmon

Finally: Goldman Sachs CEO David Solomon told employees this week that if the bank's Marcus subsidiary were a Silicon Valley startup, "people would be throwing money at us." Meanwhile, JPMorgan CEO Jamie Dimon shut down his own digital bank, Finn, entirely.