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Logistic function

Legal Risks in M&A, How Do You Quantify Them?

The AT&T, T-Mobile deal marked a great relief for consumers from a competition standpoint, but also a large quarterly loss for AT&T given the exorbitant break-up fee they agreed to pay in the event of that the deal falls through.

Last year in June, I wrote about the harmful effects to consumers from the proposed merger, however what I have also been interested in is quantifying the regulatory risk that companies may run into for either cross-border transactions or ones which may harm competition.

My original approach on working with large M&A data sets was to unsupervised learning techniques such as cluster analysis to cluster transactions into distinct groups, yet this technique gives no good method to make future predictions. Rather such a technique would only allow a primitive classification of the deal being analyzed with the historical transactions. Of course, building a classifier for a multi-categorical data set would be possible, but perhaps an easier method would be to utilize logistic regression.

The Need for Numbers

The issue historically has been the difficulty of placing a hard physical number of the likelihood of a deal facing legal scrutiny to go through. Surely, there must be associated patterns hidden in M&A data that may reveal whether one or another legal firm (Linklaters or Sullivan Cromwell) are better at such tricky issues.

The use of logistic regression is a viable method to estimate the probability of success. Given a data set of M&A transactions limited to within a specific time period, we can classify transactions as either having succeeded or failed and according to a range of variables (deal size, financial advisors, legal advisors).

The beauty of the logistic function is its range boundaries are between 0 and 1 for all x in R, which works well in the case of probability estimates. Thus we can define a Z to be a linear combination of selected variables which would have a domain in R. The linear coefficients in Z are regressed against the chosen variables and data. We would be able to make a prediction for the probability of success P(Success) based on the inputs of the variables we have chosen for our predictor equation.

This is a very early stage idea which arose out of the interest in quantifying risks in M&A and thus could provide a basis for event driven trading strategies or event driven M&A insurance underwriting.

Forbidden City in Beijing

In my past two years at Berkeley, I have seen a rapid growth in interest in on campus entrepreneurship. However when it comes to entrepreneurship, Berkeley’s impact on the Valley is not as well known in popular culture. Berkeley is a system which teaches one how to adhere to a system and how to succeed in one, which sets its students up as great employees, but not as great employers.

In summary, the fundamental debilitating issue at Berkeley is the risk aversion exhibited by its students. This was the main reason why I chose to build out the Kairos Society fellowship at Berkeley in order to catalyse the undergraduate entrepreneurship spirit through creating a tight knit group of student entrepreneurs working.

When I reflect on my time in Asia this summer, I see similar issues between Berkeley and Asian society which hold back entrepreneurial activity. To clarify things before going forward, I must state that the form of entrepreneurship I am referring to here is of the ‘grassroots’ kind where a great idea is funded and grown from scratch.

In Asia, the notion of entrepreneurship is fundamentally different. For one, a greater majority of entrepreneurs are involved in mass scale manufacturing as opposed to less capital intensive and scalable businesses. It is often very hard to come by ‘grassroots’ type startups which are doing something truly innovative. For those ‘grassroots’ startups that are innovative, there is still the dogma of adhering to a process in creating a company. Now it is never bad to have plan or a process, but the process I am referring to here is of where teams apply for successive business plan applications to incrementally scale.

This kind of practice has its roots in shame-based Asian culture. In the West, guilt-culture is a form of social control whereby individuals are kept in line through an internal sense of morality. In Asian shame-based societies, social control is obtained through the connection of shame to the family name and the subsequent threat of ostracism. Thus, shame-based cultures have an associative effect for both good and bad actions. Applied in the context of entrepreneurship we see that the associative effect of one’s actions with one’s family creates substantially more downside risk for a budding Asian entrepreneur. In an industry where the likelihood of success is low, this specific cultural feature creates an even greater downside risk which for most is too much.

I wrote in April this year on the features which make the Valley what it is (Business Today Article) and a summary of that article would be that the Valley is truly a place where startup failure is not frowned up on. The same cannot be said in Asia, where startup failure becomes a social stigma.

Now there is no doubt there are a great number of startups that have also developed in this tougher environment (Alibaba, Baidu and Weibo to name a few), but you may also notice that the founders are generally older and came into the venture with good financial resources. For all the talk of building an entrepreneurial culture both in the workplace and more broadly for venture creation, Asia today is at a real crossroads with its ancient cultural practices. The question is not whether there will be more hot Chinese internet companies to emerge (these will develop for the most part as good geographical transplants of U.S. ideas), but whether more innovative and game changing companies will be created by the younger generation, people my age with little experience, but a creative mind and a hunger to realize them.

Congested HK Skyline

This past summer I was fortunate enough to visit the Asia after a long hiatus. My first visit to Hong Kong was four years ago during that visit I had the impression that it was a city all too small for an extended stay. This summer however was my first extended stay in Hong Kong and apart from the plethora of new opportunities opened by four years in age difference, the city did have a lot more to offer and see.

Tsim Sha Tsui & The Chinese Tourist Mob

Chinese Tourists Raiding LV Store

Despite its small size, the city of Hong Kong can be quite diverse in its many small suburbs. Central and Wan Chai are predominantly expat areas with Lan Kwai Fang being at the heart of HK nightlife. Though I did have many memorable nights in Lan Kwai, in retrospect my favourite area would have to be Tsim Sha Tsui. Unlike Central, TST has just the right amount of commercialism blended in with a touch of spice that makes it seem more genuine when you’re not spending cash on luxury items. In TST, you’ll find your batch of expats, tourist, locals, mainland Chinese but also Africans and Indian tailors whom speak Chinese. Added into the mix you’ll also find a bevy of laid back beer bars (recommend Ned Kelly’s last stand) plus more higher end bars and clubs (Aqua).

Of course with that being said, Hong Kong is known for its luxury goods and you’ll find them at TST as well. What makes TST different is the horde of mainland Chinese tourists raiding luxury goods stores as the picture above shows. On many occasions whilst heading into the office on weekends, I had the opportunity to observe a viking style pillage of the Louis Vuitton store in TST Peninsula. It usually starts with a tourist bus dropping 30 or so mainland tourists followed by a guide.

The group will congregate with the guide announcing the group’s time limit plus the benefits of buying in Hong Kong due to the luxury goods tax added on the mainland. Then the fun begins. Standing on the second floor and looking down, one gets an omniscient view into this commotion. What is fascinating to this is the propensity for the mainland Chinese to carry large amounts of cash abroad. Though this practice has lessened in recent years, if one observes carefully, small suitcases and bags loaded with RMB are still prevalent. When it comes to check out, the amount of goods that are brought is truly astonishing. A massive (and obnoxious) LV patterned bag for a short stocky Chinese man, small LV bags packed to the brim in a larger LV suitcase and so on. Before you know it, the horde has left and store looks odd due to the absence of display items being brought in large quantities.

To the careful observer, it is absolutely fascinating to see this materialism and insatiable appetite for luxury goods. Seeing many instances of stores being raided viking style was one of the experiences which made TST more “out of the box” than any other areas in Hong Kong. For me, you need some spice in life, something very different and TST definitely has flavours for the discerning taster.

Mong Kok – Haggling and Its Lessons

Mong Kok Night Market

Mong Kok is a region of Hong Kong, which is known for its vibrant nightlife and shopping culture even up to 2am. This part of town has an interesting mix of markets for a plethora of fake goods and it was here that I came one Sunday evening with a colleague in trading.

Wandering through the many streets of fake electronics, one could not help but stop and see (and laugh) at the many replications of original equipment. For instance, Dr. Dre headsaets, Apple iPhone USB and so forth. Though there were many cheap and cheerful goods, my biggest takeaway was how to negotiate and drive a hard bargain which applicable in so many other areas of life.

At a younger age, it is very imperative to develop negotiation skills and ways of meeting halfway as opposed to yielding. Of course, haggling at a market will be different than in a sell-side M&A situation, but haggling does nonetheless sow the seeds which will bear fruit later down the track.

Like TST, Mong Kok can be a little run down for the discerning tourist, but one has to only dig a little to find an interesting experience and have fun while haggling.

Hiking & Stanley Market

Stanley Market Waterfront

My last stay four years ago was too short to do any “non-touristy” activities, which was why I was left with the impression that Hong Kong was a one dimensional city. This summer however, I discovered the hidden gems laying on the south side of the Hong Kong island, namely hiking trails and Stanley Market.

Though the city of Hong Kong is very congested and built on a the small amount of flat terrain facing Kowloon, the rest of the Hong Kong island consists of hilly terrain that opens up into nice sand beaches on the south side. Due to the small size of the island, one doesn’t have to go for to get a slice of nature. Trails like Dragons-Back wind through the hilly terrain behind the sprawling office towers. The terrain itself can be very steep and presents a decent challenge for any amateur hikers. The trails’ proximity makes them very convenient even for the busy professional to get away from the hustle and bustle of the Central district.

Certain trails will also cross the peaks straight to an area called Stanley Market. Stanley is essentially an upscale Mong Kok selling locally produced and antique goods for mainly Western tourists. The market is small enough and filled with an interesting array of oriental antiques for gifts or personal use. It is also very close to a bevy of bars which allow drinking out on the streets.

The ability to drink freely in the open in Hong Kong is one of its libertarian perks, but in the context of Stanley it is just wonderful. One can stroll through the markets or street with a icy cool Corona in hand and actually enjoy the humid weather with a touch of cool ocean breeze.

Stanley Market is definitely one of the more laid back places I visited during my stay and it is a great destination for a Saturday hike and some beach time during the afternoon.

Then & Now

The economic history of the last century has been marked by sinusoidal swing between government fine tuning of the economy and free markets. The failure of the Federal Reserve to intervene in the wake of the 1929 stock market crash was the turning point for the adoption of Keynesian economics. Today we see a strikingly similar repetition of the past.

Although the world economy did not plunge to the depths that the US economy did during the Great Depression, the cycle of government and control and free markets is very apparent. A system of economic modality is only as good as the bubble it can sustain. When the bubble bursts we see a new system introduced. This back and forth motion between government intervention and free markets was very evident during the Great Depression, the Great Stagflation and today in the aftermath of the 2008 Financial Crisis.

An IB economics teacher once told me that economics is akin to driving down a hilly stretch of road with the front windshield covered. Indeed, our modern economic tools have not yet able and will never be able to allow mankind to have a-priori knowledge of the future state. It would appear that the world economic modality is condemned to a cycle between government and free market economics. It is as if the world is a blind child navigating its way through an alleyway of infinite length. Only when we have hit the wall do we realize that it is too late, the economy has overheated and a new direction must be taken. In light of this we must accept the fact that the rules of the game in the competitive landscape has changed.

The massive government bailouts and stimuli following the Financial Crisis is already a sign that the economic modality has shifted towards intervention. The recently introduced Frank-Dodd Act in the United States places quite drastic regulatory reforms on the financial services industry and as introspective analysis of what went wrong nearly three years ago continues we can only expect to see more regulations.

Businesses operating in this more complex environment must be prepared domestically to vie for weaker demand, but also face tougher competition from emerging markets. In some ways, the Financial Crisis lessened the gap between developing and developed nations as much of the economic set backs were felt in those nations with the greatest exposure to the financial services industry. From this we can infer that the power asymmetry we saw during the Cold War with the world roughly aligned in a binary opposition is far weaker today. Developed economies are facing a spending limbo as they try to reduce massive budget deficits. The world is becoming more fragmented with localized powers such as China, Brazil and India emerging to challenge the hegemony of the United States. For these emerging powers, their growth model is very simple – copy the technologies and growth mechanisms that have propelled the developed nations to their place.

This growth model is most apparent in China, where labor costs are rising to such an extent that we are seeing the beginnings of a shift towards higher value added products in computer software or photovoltaic modules. China currently has significant market share in solar wafers and has put massive emphasis on the production of light emitting diodes. Now these technologies are by no means cutting edge in developed nations for they have been around for at least a decade. The key question is how will developed nations grow in the face of stiff higher value added technological production from emerging markets?

For the United States, the answer can be found in Silicon Valley which is still the innovation capital of the world. Research being conducted in nanotechnology and the University of California, Berkeley or genomic sequencing at Stanford University will be the key for US growth. We have witnessed this type of innovation driven growth in the US during the 1980s with the rise of Microsoft and IBM, both of which revolutionized the way professional work is conducted. The emergence of information technology has subsequently spurred a plethora of nuanced industries. However, since then we have seen too much speculation in very low entry barrier internet companies and the financial markets. Such irrational exuberance as John Maynard Keynes once said is not sustainable. The United States and other developed nations now need to focus on ground breaking innovation once again.

Such innovations need to be outside the internet startup paradigm, for they need to be completely new and radical technologies which can truly change human living standards. Technologies such as genomic sequencing for personalized medicine, nano-scale targeted drug delivery vehicles or even the long talked about fusion reactor need to have more funding to make them a reality. Though these technologies may be capital intensive and require significant research, the returns if successful will far outweigh the costs. This shift in funding may be from government and market solutions. Already we see that a significant number of internet startups are being acquired by large conglomerates like Google or Cisco. This trend of consolidation will continue and may shift more focus for entrepreneurs to lucrative new technologies in the fields I have mentioned above. In conjunction, governments and the private sector must also take measures to educate more young students in math and science based subjects to offer a ready talent pool that is needed for the major technological breakthroughs.

Indeed, the mean reverting nature of world economic paradigm has put us in a period of increased government regulations, while also allowing developing economies to play catch up. Speculation and the movement of capital which fuelled the Financial Crisis are not sustainable growth models. Developed nations must be willing to accept the reality that a more long term growth model in real innovation is required which has the potential immense long run returns. My vision for world growth and innovation is thus that we will see a world with greater power distribution where developing nations copy the growth model of the developed, while developed nations must pursue real technological innovation.

Photo Courtesy of Flickr

With the August 2nd deadline looming, the big question on a lot of people’s minds is the possibility of default for the United States. A temporary one would absolutely smash investor confidence in the risk free US treasuries which have been regarded as the safe haven in the modern financial era. But for better insight let’s look at a comparison of spot yields for different nations which have experienced debt servicing difficulties.

For those of you who’ve My Big Fat Greek Wedding, you’ll know that with exuberance comes a cost which cannot be sustained by the fruitful gains of others. The recent spate of news around Greece is a result of policies which have been too short sighted in their vision. As a result, the Greek 2 year bond spot yield to maturity (YTM) has skyrocketed in recent months as shown by the following chart:

Photo Courtesy of Bloomberg

This year to date chart shows the dramatic increase in spot yields from less than 10% in January to now more than 30%. This is truly an astonishing increase, but for a better comparison its worthwhile looking back 3 years to see the progression of yields as news of a possible Greek default surfaced and to see how this compares with a timeline of US announcements.

Photo Courtesy of Bloomberg

The chart above shows the percentage change of spot YTM based on a base level 3 years ago for Greek 2 year benchmark (green), Portuguese 10 year benchmark (Orange) and US 10 year benchmark(Dark Orange). As we can see from the following the chart, the current YTM has in fact decreased compared to 3 years ago, in part driven by strong buying after recent turmoil in European treasury markets. If we were to look back at 1H 2010, when news broke of Greece deficit troubles, we see significant spikes in YTM.

Compared this with US spot YTM and we see a significant difference. Although an incredibly low Federal Funds Rate in addition to safe haven buying are factors to be considered in analyzing current US 10 year YTM, it must be said that if investors ever had an inkling of the possibility of US default being a real and serious threat, the YTM should then be much higher than today’s levels.

Despite a string of recent news on the roadblocks in Republican and Democrat negotiations, the market has apparently not priced the risk of default with a high probability. The risk of default for the US is on the tables, albeit small according to information from the market. Expect markets to become more mercurial and VIX to swing up as news and announcements trigger hairpin decisions by speculators on both sides of the trade.

A few weeks ago I wrote about my experience at TEDxSF V ALIVE! and indeed that was an inspiring experience. Too often we are caught up in the back and forth motion of a routine, which stifles creativity and the desire to explore.

To live a balanced life one needs to be inspired, to step outside of one’s comfort zone and embrace what the greater world has to offer. This can be in the form of acting on a crush, off the beaten path travel or in my case meeting people from diverse and interesting backgrounds. Having had a relatively windy upbringing with both Kiwi and Chinese heritage, I could I am a new breed of generation X’ers born into a supranational identity – never too patriotic as too stifle an inherent desire to explore.

Being armed with this ethos, I signed up for a volunteer event over the weekend to help refugees stranded in Hong Kong. Going into the event, I must admit it has been a while since I’ve done this in IB and the objective wasn’t clear cut to build something tangible.

Upon arrival at the missionary shelter in Tsim Tsa Shui, the entire BarCap was greeted by a friendly group of refugees from a cornucopia of backgrounds. Present were refugees from the Middle East and Africa. As we waited they seemed all very brotherly, able to interact freely without cultural or racial divides. What tied all of these people together was their common predicament of being aliens with no rights in Hong Kong.

As the day progressed we switched locale to a lovely beach on the Kowloon side of Hong Kong. We were able to hear their stories individually and the length of time some of them have stayed is truly astonishing – 6 years for some. Behind all the jovial laughter one could really sense the intangible, but nonetheless tremendous impact of being in a foreign land without legal rights.

Imagine yourself to be displaced, and living on a stipend but not able to exercise your abilities to add value to society through employment. Put yourself in a situation where you do this for an extended period. The mind deteriorates because of this limbo state and it was really a testament to the human spirit how these refugees were able to remain cheerful and happy given how long they’ve lived in such a predicament.

For the Somalian refugees, it is an especially sad story given that Somalia has not had a legal government since 1991. More than half the country have been displaced externally. Though Hong Kong may be heaven compared to the streets of Mogadishu, the human free will to achieve will ultimately shine through and thus it is truly sad to see such stifling policies put in place on such capable individuals. In a very market sense, these policies are almost akin to planning.

Though the BarCap team did not build any houses or water taps, we did something just as substantial and that was to alleviate a dozen or so siloed human minds from the stationary nature of their lives. It was interesting to spend a day with them, seeing how they lived I realized I am myself.

Given the hustle and bustle of every mundane, one needs to go out of their comfort zone, explore a little bit, gain a new perspective, be grateful for where they are but always strive for more – to be the most holistic human being one can be.