Snap’s IPO Shares Should be “Junk Equity”: CalPERS

The scam around the shares of Snapchat’s parent, and a revolt by institutional investors that may have to buy the shares.

The publicly traded shares without any voting rights in a company totally controlled by just two guys should be labeled “junk equity,” said Anne Simpson, an investment director at the California Public Employees’ Retirement System (CalPERS), the largest public pension fund in the US.

“You’re constraining the capital markets in a way you’ll come back to regret,” she told the SEC’s Investor Advisory Committee on Thursday, as reported by the LA Times. “Innovation, we’re interested in that; but this is an immature attempt to avoid accountability.”

They were discussing the non-voting shares issued during the IPO of Snap Inc., parent of Snapchat. It was the hottest tech IPO in three years when it went public last week, though its shares have had a very rough time this week.

Snap was on the forefront of financial “innovation,” bravely going where no other IPO had dared to go before: issuing only shares without voting rights. The two founders retain total control. Some early investors have very diluted voting rights. But those who own the publicly traded Class A shares just have a pile of hype in a company that, according to its pre-IPO S-1 filing, is likely to lose money until the end of its days.

Normal ownership rights – having a say on the company’s strategy, the pay of its executives, the board of directors, etc. – would threaten the two founders, given the financial performance of the company. It’s better to keep the mob of frustrated shareholders at bay.

Ken Bertsch, executive director at the Council of Institutional Investors, which represents pension funds and large institutional investors, told the SEC meeting that input by investors has led “to the vitality of American capitalism … even when egos are bruised, strategies are upended, and executives” get forced out.

If Snap gets away with this, issuing non-voting shares will become pandemic, and shareholders will become helpless dupes.

In early February, when Snap filed its S-1 with the SEC, I published a scathing report about Snap’s planned IPO, its slowing growth of users, its ludicrous valuation, and the disclosure that it would pay Google Cloud $400 million per year on average over the next five years to host the site. Snap’s 2016 revenues were only $404 million. That doesn’t leave any money to cover employee compensation, office expenses, and a million other things companies pay for. Hence losses as far as the eye can see.

These are the risks IPO investors are willing to take. Lose nine, win one big. That’s the hope. I wrote:

But there is something much more important at stake: surrendering your voting rights. And if equity investors – this includes institutional investors that will back the IPO – don’t revolt now, it’s going to become pandemic.

And now institutional investors have woken up. The revolt has started.

The Council of Institutional Investors has come out against non-voting shares in recent days. Its point of attack is where it hurts: Pressuring the providers of major stock indices, such as the S&P 500 index, to exclude non-voting stocks. When S&P Dow Jones Indices and MSCI said they’ll review the inclusion of Snap in their indices, its shares plunged for two days in a row.

Much of the hype was focused on inflating Snap’s market capitalization so much ($24 billion on its first day of trading) that it would have to be included in the S&P 500 Index and the MSCI USA Index. And that itself became the selling point of the IPO.

The whole thing resembles a scam, as I wrote on March 6 [Investor Group Attacks Snap’s No-Vote Shares, Stock plunges]:

The bet was that once the shares are in the index, the real buying would commence by funds that track those indices and would therefore have to buy the shares. Given the relatively small number of shares traded, this buying pressure across the globe would push up the price even further. It was simply a matter of creating a lot of artificial demand.

It’s not uncommon that voting rights are stacked against holders of publicly traded shares. The founders of Google and Facebook have set up such systems to protect themselves against the wrath of investors. Companies with disproportionate voting power represent about 12% of the S&P 500. But only Snap has created a structure where all its publicly traded shares are non-voting.

Even the SEC is finally waking up. Kurt Schacht, who chairs the SEC’s Investor Advisory Committee, warned at the meeting on Thursday that issuing non-voting shares “might be the next big thing.”

Kara Stein, one of the two current SEC Commissioners (there are normally five), told the meeting, according to Reuters: “Unequal voting rights present complex and new issues that need to be understood and addressed.”

“We also must be mindful of the precedent being created,” she added. The SEC should study companies that in their IPOs offer shares without voting rights, with a “focus on how some innovations may prove detrimental to investors.”

“In the long run, we need to critically assess our regime for initial public offerings,” she said. “The current structure is premised on taking investors’ capital while giving the investor rights to hold that company’s management accountable of that capital.”

The Investor Advisory Committee didn’t reach a conclusion on Thursday; and deeper discussions will follow in a subcommittee hearing.

On the surface, it seems there’s a solution right now: Investors could just stay away from Snap’s toxic non-voting class A shares, letting them fall into penny-stock territory where they could languish until the company figures out how to make money, or until it folds, whichever comes first.

But that option might not be possible for institutional investors, such as index funds and pension funds that track stock market indices. They have to buy the shares once they’re included in the index. And that’s where the scam comes in: hyping the stock and driving up the price to where market capitalization is high enough for the stock to get included in the S&P 500 and other indices which would then force these pension and index funds to buy the shares.

This forced buying creates artificial demand, which allows early investors and insiders to exit at peak valuations, and it allows the company to issue more shares and raise more money to cover its losses for years to come. In the end, it’s in those funds, forced to buy the shares with other people’s money, where the shares will wither until they get dropped from the index on their way to oblivion.

The Financial Sector threw $2 Billion at Congress during the last election cycle. Biggest Spenders? Not the Banks. Read…  Why No One’s Going to Drain this Swamp

Enjoy reading WOLF STREET and want to support it? You can donate. I appreciate it immensely. Click on the beer and iced-tea mug to find out how:

Would you like to be notified via email when WOLF STREET publishes a new article? Sign up here.

  43 comments for “Snap’s IPO Shares Should be “Junk Equity”: CalPERS

  1. TheDona says:

    It was my understanding that a company had to show 4 quarters of earnings to be included in the S&P. Did I miss something?

    • Guido says:

      Can’t SNAP start paying equity a la CRM/AMZN as part of salaries and show “earnings” just like these companies have been showing for more than two decades? I am guessing SNAP can let the markets pay for the salaries (SNAP writes up stocks, issues them to employees who then cash it out in the market on the backs of CALPers et al) and reuse the cash towards their earnings. Once they do that, don’t they satisfy the requirement you stated to be included in S&P?

    • Wolf Richter says:

      You didn’t miss anything. I also pointed that out in the March 6 article. But none of these rules are iron-clad. Amazon doesn’t usually have four quarters in a row of profits either, and it has been in the S&P 500 since 2005.

      • interesting says:

        If i don’t have profits EVERY quarter I’m out of business……what a scam.

        • Wolf Richter says:

          If you had unlimited investor funds to burn through, think of what you could accomplish? Forget sales… you’d come up with your own metrics to show how successful your company is.

          For example, “hours spent staring at a computer.” Then you would chart that on a quarterly or monthly basis, and make it look good and tell analysts that this is the key metric to watch, and they’ll watch it intently, ooh-and-aah over it, and comment on it in glowing terms, and more investor money would flow into your company to be burned as fast as possible, and you’d be a hero.

        • <<>>

          You could start an energy company.

          : )

      • Steve Pisc says:

        But then again Amazon isnt a legitimate company, it is currently MIC, as is Google, and was created from the beginning with that intention…..With Amazon once enough retail markets close, they will have a stranglehold on the entire economy, with easier implementation of the “digital currency.” Google is there to do the same with news and basically access to all online info….I dont even think Tim Cooke is real, i think he’s a nominee for the world’s intelligence agencies….Apple has been MIC since Jobs left.

        • Marty says:

          No, Steve. Jobs was never real, either. Apple has always been MIC.

        • Wilbur58 says:

          What is MIC? (I’m sincerely asking.)

        • TheDona says:

          Steve, so it makes sense to add FB to the MIC companies because of their algorithms and ability to spy on/keep track of people. In the past, private companies were funded with taxpayers money to co-develop projects for MIC. Now it appears these companies are blatantly funded with taxpayers FUTURE earnings, retirement, pensions. Hide.It.In.Plain.Sight (or site in the case of FB and Google). The bullish stock market is the spoonful of sugar to help the medicine go down for us rubes.

        • Barry Svenningson says:

          Companies working on “Alternative facts”, like the White House?

      • Spanky Bernanke says:

        Or, an ETF fund. BUT, it can’t be derived from a currency that actually appreciates in value. The SEC Friday decision tells me one very, significant factor–we are going to screw over all the generations, except for Boomers and we are willing to blow up the monetary system to prove it. I fear NOW more than ever, that some absolute morons run our Administrative agencies and their biggest concern is making sure they are rich. Our capital system is COMPLETELY fraudulent and the SEC is more than willing to blow up bubbles and pop them to watch the sheeple suffer. I now understand the potential destruction of the securities and derivatives markets–I suggest you start looking at alternatives as quickly as possible…

  2. Dave says:

    Why cant index funds and pension funds change their rules to NOT buy any stocks that dont provide sufficient voting rights?

    Easy fix!

    • Wolf Richter says:

      They wouldn’t be “index funds.” They’d be actively managed funds, with fund managers making decisions what to invest in. That’s a different type of fund.

      • Mel says:

        Do index fund managers have an obligation to vote the shares of the companies they’ve bought? My gut says no …

      • Emanon says:

        If a few big firms such as Vanguard decided to draw a line in the sand, they could change the name of their funds to the “S&P 499” or “S&P 500 – 1” and just refuse to buy the damn stock. That would kill the idea faster than the SEC.

        Allowing a stock to float with NO voting rights for anyone except two people (!) is like letting a patient with ebola walk around in public with no medical precautions. Soon EVERYONE will try to pull the same stunt.

        Our financial marketeers aren’t even trying to be honest anymore, they are too lazy to even bother to lie to us.

      • d says:

        The other thing that could happen, is it will only take 2 or 3 “snaps” in the, S&P, MSCI.

        To kill index fund’s, as a viable investment vehicle.

        Something that would be detrimental to the indexes, and more importantly.

        Some of the shakier companies in those indexes. Who get a lot of undue support, from the index fund’s.

        I expect so serious “private lunches” to be taking place, over this issue.

  3. mean chicken says:

    So many swamps to drain, nothing has been done. We’re probably losing half or more of our wealth to fraud.

    Sp calpers must but the index, that’s simply a license for fraud.

  4. interesting says:

    “shareholders will become helpless dupes”

    LOL, and in other news, water is still wet, fire is still hot.

    that’s what a casino is all about isn’t it?

    • Kent says:

      Yep. What exactly is a “non-voting share”? Especially of a company that has no ability or desire to pay dividends? Isn’t it just the right to speculate on the future value of that share? So who says only SNAP can issue those speculative bits on a disk drive somewhere? Why can’t I?

      • Petunia says:

        Non voting means you don’t get to pick directors, who then get to pick auditors, accountants, bankers, and ….. the compensation committee members.

  5. Bobber says:

    Your chances of catching a 50 bagger at this stage of the market cycle are slimmer than the return on a CD.

  6. What’s happening w/ SNAP isn’t much different from other firms who are borrowing w/ both hands to buy back shares, or borrowing to pay dividends.

    Add self-pay, ‘forward guidance’, non-GAAP accounting, bought-and-paid for analysts and HFT and you have a pure-simple Ponzi scheme.

    “Abandon all hope ye who enter here!”

  7. MC says:

    When the Chinese Alibaba Group went public in 2014, they did it so on the NYSE for a very simple reason: all three main Chinese stock exchanges (Shanghai, Shenzhen and Hong Kong) have rules clearly forbidding the sale of non-voting shares. Jack Ma, like SNAP owners, just wanted investors’ money, not their opinion on how to run the company, even if said opinion was fully paid for.
    The NYSE is one of the very few stock exchanges in the world allowing the sale of non-voting shares. Even the notoriously opaque City of London forbids the practice.

    Given the mass of capital still flowing into US equities, it’s likely SNAP shares will rebound somewhere down the road: it’s the most hyped IPO of the past four years or so and it just needs to be successful. Plus I am sure I am not the only one who’s already heard “But FaceBook had an IPO price of $38, went all the way to $18 and look where it is now”.
    Yes, but FaceBook generates profits, unlike SNAP, Tesla and the rest of the financial black holes whose “investors” think are the next Apple.

    • d says:

      “Jack Ma, like SNAP owners, just wanted investors’ money,”

      At least Alibaba sort of makes money, and it does have that big red, “WARNING we fully intend to rip you off” CCP flag attached to it.

  8. JB says:

    come on people you are being too cynical. the execs of SNAP want to avoid an activist investor scenario such as Carl Icahn.

    If you don’t like the stock market flip houses .
    Just kidding .

    An interesting side note: Any purchaser of an ETF forfeits his proportionate share of voting rights to the etf maker from what i am reading.

  9. hidflect says:

    “Unequal voting rights present complex and new issues that need to be understood and addressed.”

    Exactly the sort of disingenuous, non-statement we’ve come to expect. What’s to understand? Is this woman congenitally, mentally impaired? Does she need help finding her way to the bus station?

    These are dark days. We’ve long come to understand that the consumer has been thrown under the bus. e.g. where I am, products no longer require country of origin labeling. So if they don’t say, I don’t buy.

    But now even the OWNERS are getting shafted. This all reminds me of the few USA activist shareholders who tried to dent Japan’s arcane corporate policies with little-to-no result. Ironically, the “reform” has spread to the USA not visa versa.

  10. Petunia says:

    1. Why doesn’t CALPERS change its rules and forbid the purchase of non voting shares. Seems easy enough.

    2. Snap, as a product, claims to create videos, photos, and messages, that disappear after being viewed. They claim to do this while being hosted by/in the Google cloud. Does any body using this app really believe that? I don’t.

    • JB says:

      valid point , however from what i can glean from available resources is that any CALPERS investment in an index fund(ETF) is void of voting rights . Can’t find their portfolio mix however it must be in the billions. SO what is their issue ?

      • Petunia says:

        As far as I know, ETF’s don’t own shares, they own the option to buy or sell shares, otherwise they would be mutual funds.

        So crap or crap squared, does it really matter?

      • JB says:

        gee my bad just detail read my own post .
        per post : investment portfolio of $258 billion as of June 30, 2013. On that date, 35% of the portfolio was in passive investments and 65% was actively managed.

        over 1/3 of calpers investments in passively managed investments (non voting)

        seems like a WR article to me .

        • TheDona says:

          JB, I agree. Seems like a good Pension Fund article from Wolf would make for some good reading especially since they are backing away from Hedge Funds due to a decade of stagnant returns. Report number 2 might be about the Canadian Pension Funds…the true wild west cowboys of investments. Thanks in advance Wolf! :-)

        • Wolf Richter says:

          Thanks for the tip. I’ll look into it.

          CalPERS has so many other problems, like expecting returns (now lowered) of 7% every year for all eternity. Going to be tough.

  11. Xabier says:

    There is an almost sublime beauty about all of this, politics and finance are running in parallel:

    However you vote, in election or referendum, it will achieve nothing: shout a protest, and it evaporates into silence.

    Buy shares, and you will still have no voice at all.

    Fraudsters of the globalised economy; parasitical politicos ; shirt-lifters of exquisite deftness; governmental muggers: I take my hat off to you!

  12. Oh please! says:

    “input by investors has led “to the vitality of American capitalism … even when egos are bruised, strategies are upended, and executives” get forced out.” …. what vanity and rubish! America has lost many great companies to rent seeking “investors” who take the reigns over from the originators and drive the company over a cliff.

  13. Michael Fiorillo says:

    It’s more than a little ironic that, with inequality between Capital and Labor at century-high levels, gross inequality, rent-seeking and wealth extraction should break out among the Capitalists themselves. I guess that, having extracted the wealth of the middle and working classes, there’s nothing left but for them to be predatory/parasitical among each other.

    Snakes eating their tails, and suggestive of a system undergoing massive strain…

  14. mvojy says:

    Didn’t Mark Zuckerberg do the same thing with Facebook stock? He and the insiders retain most of the voting shares while the general public gets to buy non-voting shares.

    “the company announced that it will create a new “Class C” stock that has the same economic rights as the current Class A and Class B shares but has no voting rights.

    Facebook currently has a dual-class structure. Class A shares, which are what trade under the ticker “FB” on public markets and have one vote per share, and Class B shares, which have 10 votes per share and is what company insiders own. The Class B shares don’t trade on an exchange.

    Now there will be a new Class C stock, which gives investors the ability to own Facebook but have no say on company decisions. There will also be a new ticker for the Class C stock, like “FBC” or something.

    So again, Zuckerberg has the power now and will have the power in the future. This move merely formalizes it.”

  15. Smitty says:

    Fortunately CALPERS is completely unaccountable with the State of CA making up any potential losses or non-returns, no matter what.

  16. Semper Gumby says:

    Gee SNAP is making the news again. Goldman want you to buy it. No mention about which kind of shares. Is this another case of Goldman secretly shorting a buy recommendation?

Comments are closed.