Chris DeMuth's State of the Markets March 2023 (Episode #159)

Chris DeMuth joins the podcast to discuss the state of the markets in March 2023 and what’s catching his eye in event driven land, including the banking crisis, Coinbase’s Wells Notice, JBLU / SAVE, and ATVI/MSFT.

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Transcript begins below

Andrew Walker: All right. Hello and welcome to Yet Another Value podcast. I'm your host, Andrew Walker, and if you like this podcast, it would mean a lot if you could follow, rate, subscribe, review it, or wherever you're watching or listening to it. With me today, I'm happy to have on my friend and the founder of Rangeley Capital, Chris DeMuth. Chris is on for his monthly State of the Markets podcast. Chris, how's it going?

Chris DeMuth: It's going great, Andrew. Thanks for having me on.

Andrew: Thanks for coming on for the March State of the Market. It's been a very boring month, so it'll be tough to find stuff to talk about, but I'm sure we'll do it. But let me start this podcast the way I do every podcast. A disclaimer, just remind everyone, nothing on this podcast is investing advice. That's always true, particularly true today. Chris and I have about four or five situations we want to bounce through quickly. So we're going to talk about a lot of different stocks, a lot of different situations. So please do your own work, consultant your financial advisor. All that out of the way, Chris, end of March, 2023, what's on your mind?

Chris: Banks, energy, crypto to some extent, thinking about the government's public policy reactions to all of the above and how that affects the immediate issues, and then how that affects the moral hazard and adverse effects going forward and markets going forward. A little merger arb, but maybe less merger arb than usual. A lot of litigation. I guess the thematic thought for the month for me has been, do I just keep bugging on with specific firm-level ideas and mispricing, some of which have gotten quite a bit bigger, or do I set that aside? Is this a time to take some big directional swing and say, f it this whole sector or market is too expensive or too cheap, or do something dramatic? I have not done anything dramatic yet, and I haven't even fully enunciated a dramatic response. But when everything moves a lot, I always think most strong reactions or overreactions, and maybe there's something you can do against that tendency. But I've mostly just been keep working along on individual things we've spoken about in the past. A couple new ones, a couple old ones.

Andrew: I want to start with the banking, but it is crazy. You say most strong reactions are overreactions. And I remember at some points this month, First Republic stock would trade, it opened the day at eight and it closed the day at 60 and it would've closed the prior day at 80. So you're talking about, if you could time it correctly, you could get like 10x moves both ways and stuff. The volatility here was just absolutely wild. But I do want to start...

Chris: If you can time it correctly is a big... it carries a lot of weight there.

Andrew: It really is because... it's been crazy because you could wake up... Silicon Valley, you wake up one day and you're like, oh, the stock had a rough day today, but book value here is... If you just looked at the financial statement, you'd think, oh, book value is 200. Everybody thought Silicon Valley had a valuable franchise, and then the next day the stock just doesn't open. They closed the bank, Signature bank over the weekend, over the complaints of management, though I think there were issues there. They just closed the bank. And First Republic, I think people would've looked at it as like gold standard banks in terms of brands and operations and stuff. It seems pretty clear that the equity as you and I are talking is trading into the mid-teens. It seems like the equity's got a real chance of being a zero or they're going to have to take huge, huge dilution to get bailed out. It's like, you can just wake up and all of a sudden, your banks is zero and it's crazy. It's very difficult to think through that environment.

Chris: First Republic's the one that I'm far and away most familiar with as on the customer side, not on the equity investor side. My worst five-second glance at something that I moved on without delving deeper into was having just an over-the-moon customer experience with First Republic. Things that I've had to by hand explain to commercial banks and beg, First Republic just rolls out the red carpet and they get some brilliant Ivy League person who's just head and shoulders above any kind of wealth management person I've ever been in contact with. And they can do lending against GPs. They can do all sorts of really clever lines of credit. They can do... I won't even list all of them, but customer service things that are just beyond what you'd think a bank would do. And I thought, oh, maybe this would be a good equity, and I looked at the equity at one point, this was a little while ago, and I was trading it two times buck or something. Like, oh, I can't own that. That's way too expensive just on value. And I never thought like, oh, this is a good short idea. And it's probably a lot of their very happy customers that just casually and price insensitively bought this stock. But it's...

Andrew: It's funny you say all that stuff they did because at the time it sounded great. And I remember when... in a prior light, I was at private equity and I remember they came to me at some point and they're like, "Hey, here's a loan for you, but we're giving you this loan not because we're going to make money on this loan, but because we want to establish a holistic relationship. And when you do a mortgage, you want to add that mortgage to your bank." And at the time, it sounded great and I was like, 'Oh, what great customer service. What a great way." But in hindsight, I'm like, isn't that a show? You've got these companies going... Banking is a commodity industry and yeah, they're trying to do things above and beyond, but that's generally how people get in a lot of trouble. Like underpricing things with the hope of giving things later. That's how you get in a lot of trouble. And First Republic, there's other issues there, but just in hindsight, I'm like, oh, what was great customer service and going above and beyond, is that the sign of a show?

Chris: And some of the things, I think I won't mention right now, but we're really high touch, really high expense things. There's a dark side too, and maybe related to what you just said, working at private equity and there's a dark side that related First Republic to Silicon Valley, which is... it's Payola. This is the commercial bank equivalent of a soft dollar account. This is buttering up agents to get them to do things for the money they're responsible for. The top 10 accounts at Silicon Valley Bank was $16 billion of deposits. That wasn't people who neglected to notice that that was somewhat over the $250,000 FDIC cap. Those were people who were getting 2%, $10 million loans for their houses personally, and in return, we're putting all of their firm's, capital in this one account. And that was the deal. That's the deal at First Republic. That was the deal at Silicon Valley Bank, and so that's Payola. And so that proved to be very skittish.

Andrew: I understand banking is a confidence game and look, I get you have to... I get if you start letting deposits go under or get taking haircuts, you could have real crisis and contagion issues and stuff. But at the same time, I look at the Silicon Valley Bank, and I think circle the USDC, the US stablecoin, I think they had over $5 billion in cash in Silicon Valley Bank up to three days before and they managed to get some out. But when Silicon Valley Bank closed, they had $3 billion worth of cash in it, or Roku had $500 million of cash. And I just look at that, I'm like, everybody knows what the FDIC limits are. I understand you don't want contagion, but at the same time, if you've got people parking $3 billion worth of cash and banks and the banks fail, shouldn't be like, hey, you pay a corporate treasurer. You know the risks, we have to give you a haircut because all you have to do is move it over to a money market fund. And I understand the company probably had credit line agreements with First Republic, but at some point you're taking that risk. It seems like you have to do it. I don't want to haircut mom and pops, but $3 billion in a bank just struck me as what are these guys doing?

Chris: I've been very interested to watch the public policy response so far. I always think arsonists have a field day when there's already a few houses on fire and the government was able to come in and really settle some old scores, and I think that that was most vivid to me around crypto. Maybe somewhat around private equity as well. But if you looked at the crisis mentality rescues and the government emergency response, it was in many ways opposite of what I would do. I would look in and say, look, we have a 60-day antitrust-free zone, anybody who wants to run in and rescue somebody, gets to rescue them, will sort out pricing power later. You get to do deals, we're going to do private market reactions and the government's not going to get in the way because you look at some of the potential saviors, and I would look at TD and I'd say, okay, so one, they could rescue FHN. Two, they could rescue Charles Schwab. They already have a big investment note really well.

So you have a foreign bank, although Canadian, so barely foreign and you have pedantic government delays that is analogous to saying no to something in a crisis. They could have let a lot more private capital come in if they would simply wave some of the normal government red tape. They didn't do that. Instead, they actually put up a lot of fresh barriers to people who looked around and said, nice rescue, you have there, but we're not going to let, for example, Signature, which I thought was one of the most interesting, immediate, over the weekend throwaway line we're taking that bank and they specifically said, "Hey, anybody wants to come in and look at Signature?" You may not turn on any of their old crypto business.

When private equity came in and wanted to look at Silicon Valley Bank, they said, "No, you're not an acceptable buyer." So the government actually interfered with a lot of the private... Capitalism is a more vicious regulator and it provides bailouts. The problem with capitalism is, a lot of the times it's the people who need the bailouts don't like the prices that the market clears at. So they go back begging and say, "Hey, I've blown everything up. I've caused this contagion. I've created the systemic risk, but I don't like how much these people want to pay me. Who want to do the private? I need more money because I like money." And the government is incredibly sympathetic to that view. That was Credit Suisse's point at the end. That was a lot of the points of the targets of these bailouts.

So the government really interfered with private market reactions and settled old scores with crypto, with private equity telling the people who they... And if you look at a lot of the other behavior around crypto, the CFTC complaint, which is definitely worth a read. And I think it's one of the defining documents of this era. Now, the crypto people were doing themselves no service if you look at what they were up to in these things. So the regulators might have had some darn good points here. But they were really doing a lot of score-settling while they were bailing out these institutions.

Andrew: Unrelated to any of this, did you read the Coin Wells notice? Coinbase's Wells notice?

Chris: Oh, yes, I did.

Andrew: What did you think? I have not read it, but just you said, and I saw the Twitter headlines I've been meaning to read. What did you think of that?

Chris: Boy, I think that the government for a while has done a pretty good job of calling their shots and preventing market panic around what is and isn't described as a security and therefore a security listing. I think that was pretty devastating. I think the CFTC, the more recent complaint against that was pretty devastating. I think these guys knew what they were doing wasn't very compliant, and I think that they're in a lot of trouble. I think there will be crypto, I think there will be Bitcoin, but I think that the SEC chairman in particular has had concerns and is going to be able to use this current situation to slam the door much quicker and more firmly than he would've otherwise.

Andrew: Again, look, this is what people come to the podcast for, right? Me talking about things that I haven't read or don't fully understand. But the high-level Coinbase argument I thought did make sense where they're like, hey, you guys approved us to get listed on the stock exchange. It's not like our business model has changed. I'm not saying that they approve, but it is like, "Hey, why now? We've been out here doing this for years, and now you're choosing the time to do it?" It held some sense with me, but at the same time, I also said, hey, you're trading worthless shit coins. The staking and all this sort of stuff seems pretty clear there's some security offerings there...

Chris: I was probably less sympathetic on the Coin response. I just so vividly remember the Chinese reverse listing frauds from 2010 or so, and the SEC weighed those all in, and they all had American auditors that had now Chinese subs that had audited them. They had the basic procedure and the SEC did eventually, years late, come in and slam the door on them. But no, once there have been damages, once there's been a focus, prosecutorial discretion works in both ways. You can come up with something that's nominally illegal but really is well within the spirit of the law and just isn't a priority. And a prosecutor just says, "I saw exactly what you did, and I'm choosing to do nothing about it." And that's a hugely appropriate part of our system and without it, we would just be spending all of our time on compliance.

But it goes in both ways. They can have prosecutorial discretion for a while, and then there can be massive damages and new information. They can say... I think consistency is a virtue, but it's a fairly low one in the pan of virtues. And you can be inconsistent by aggressively coming after something years later, even if you waived it through because now it's a priority. Now it's a focus. Now there have been damages. Now it's what we're working on. So if you're outside of the law, you can be grateful for a prosecutorial discretion, but you can't say, now I have a permanent safe harbor because somebody was lenient for me at one time.

Andrew: That makes sense. Let me turn back to the banks.

Chris: Sure.

Andrew: I did a post on the banks, and one of the issue I have with the banks is, okay, we've now seen three to five bank failures, depending on how you count all these banks and they go up and they go up quick. And I can look at a variety of regional banks, and I can find you... Depending on what you want, I can find you ones, Trading under tangible book. I can find you ones that they're trading and under tangible book. They're trading for five times 2022 price to earnings. If you and I had been talking a month ago, we would've been like, this is a great bank. This is a compounder bank. It's trading at 1.8 times Changeable book and maybe that's a little expensive, but it's within the realm of reasonableness. Now, it's under tangible book, five times earning, blah, blah, blah, blah, blah.

I guess the two things that hold me back in my mind are, number one, if you go look through the financial statements, it's not just the fair value of the held-to-maturity loans that blew up Silicon Valley Bank or the held-to-maturity securities. You start looking at the loan portfolios, and you say, hey, if you fair value these loan portfolios that there's a lot of hair there, and banks are very levered companies. Once you start haircutting these things, it gets pretty bad. Look at the Silicon Valley deal that they just sold, the loans got valued at what, like 75% a book? Once you start doing that to some other banks, 95% of books are enough to wipe out a lot of these banks.

I look at that on one side. I'm like, I don't know how much I can trust the asset balance here, even for the good banks. Small haircuts really moved the needle here. And then B, it seems like the contagions controlled, but I just keep thinking March, 2008, you and I probably said, oh, it looks like the contagion controlled. And then a couple months later, all of a sudden just everything was falling. And you do wonder, hey, is this the first domino or is this the last amino or the first domino? And then I guess the third thing I worry about is, even if you're buying a bank at tangible book and a month ago, two times tangible book was the right price, I do worry that you're going to have a lot of regulation coming in on the back end of this and banks are going to be looking at in the future, less leverage, requiring more liquidity, basically regulations, all that stuff is going to drive return on equities down. So earnings go down, return on equities go down, so they're worthless in the future. And I look at those three combinations and say, look, I'd love to run in... I think I called it in my blog post, I'd love to run in an action hero running into a burning building and just start buying banks left and right and be the hero in this panic. But I do worry, like regulation, all these concerns hold me back. So I rambled a little bit. I'll flip it over to you.

Chris: Well, I am not the action hero rushing into the burning building, but that's a lot of what I thought about this past month is saying what the hell and going for it. And I have not done that, and I'm not that tempted. I have two levels of concerns. One is the immediate Signature the government shuts them down and there is zero over-the-weekend concern and then these broader ones. In terms of the immediate concern, I look at how idiosyncratic the behavior was and the financials were in the failure so far. And I will count First Republic on that list. So the ones that either have gone under or the debt market is saying they are highly likely to. So the ones that have been seized and FRC. I think those are highly idiosyncratic.

I think they're not very much the next dozen on the list. Is there one or two that I'm forgetting that should be added to that list? I don't even think so. So that makes me fairly comfortable with the kind of dramatic early part of this crisis. But then you're still left with... we haven't even gotten into systemic... just overall credit risk and overexposure where you have these very, very low interest rates for very, very long period of time. And just the amount of mal-investment, whether that's at the banks themselves or all the places they've loaned to in their lending portfolio. So I think there's a lot of problems there. All the remaining problems I can solve with price, though. You can't solve Signature with price. It didn't really matter. If you're long signature, it didn't really matter what multiple you paid for you, that was wrong.

I think for the remaining regionals and community banks underpaying solves for the reasonably likely bad credit that they have for the increased regulation for the increased in FDIC insurance, which is going to go up a lot for what they're going to have to pay. I do think this mid-level institution that is sub too big to fail, regional, not national, but low touch and low customer loyalty, somewhat expensive deposits, I think they're the ones that are going to be most permanently impaired. And the beneficiaries will be the money center national banks and the community banks that can really afford the relationships and in some ways better due diligence on who they're lending to and so forth.

So I have a number of community banks that I think actually had deposits go up this past month that I think are terrific. They're generally pretty tiny. And for those, I would say I feel very comfortable if I thought I was underpaying, some things that I'd had small positions in the past, but kind of situations where it's like, well, I don't really like paying more than tangible book value for anything. But I was like, I was at... they're down double digits for where I was already paying down double digits from tangible book value. So now they're getting really cheap. I think cheapness... I think underpaying solves for everything there. Now, some of the characteristics are super illiquid, family dominated, and often somewhere in the demutualization process where that's where... You were talking earlier about where can you be comfortable with price as an indicator. I think underpaying solves for everything there.

Andrew: And I guess on the demutualization process, the nice thing there is you're going through demutualization process, which means you've got a lot of cash coming in the door, so you're going into a banking crisis, and if you've already done the first step, you're going into banking crisis with the best equity ratios you'll ever have, tons of cash. Maybe you're picking off competitors, maybe you're just picking up lots of market share, but that's great. Can I...

Chris: Yeah. Just one specific one that I just think really highlights that specific. I have a very small long position and it's that first Seaco FSCA, they just raised money at $10 per share from people including me. It's trading at $8.59. That $10 per share is still there. It's not like they've instantly put it all to work. But I thought $10 a share was a bargain. I think $8.59 is a bargain. I think it's a boring little investment that will have no entertainment value whatsoever. But they're just at the beginning of a process that that's an example of something where it's a prudently run little community bank and it'll be fine, and the investment will take several years to play out. But I think the margin of safety there is real and there's nothing this institution has anything to do with Silicon Valley Bank.

Andrew: Perfect. All right. Let's turn over to... I wanted to walk through a couple of regulatory things, and I just realized I grabbed the wrong hat off my desk, so I'm going to flip to the proper hat, but I want to talk... For the 10th podcast in a row, we'll talk Activision Blizzard in a second.

Chris: Sure.

Andrew: Let me just start the JetBlue Spirit deal. This month, the DOJ came out and they did what a lot of people thought they were going to do and say, "Hey, this is an anti-trust violation. We're suing to block." But on top of that, the Department of Transportation got involved. And I just want to talk... We can talk about the Spirit deal, but the Department of Transportation getting involved and they're doing the regulatory thing that the FTC sometimes has, where they can hit pocket something in a way that... or sorry, the FTC has. They can hit pocket something in a way that just kills the deal without any judicial review or any appeals process or anything.

So I just want to talk about the Spirits deal in particular, but also in general, the trend towards government agencies taking a more aggressive stance on blocking mergers in ways that don't allow for judicial reviews, appeals, and stuff. Because if everybody knew the FCC could do this with media deals, but if the Department of Transportation can do this and you start thinking like every company has some regulator do merger arbs. Do we need to start thinking, hey, the government... It's not just their judicial review where we'll get a court case eventually if the companies want to take it to court, it's actually the government will bring everything that they can to stop deals that they think are an issue. So merger arb spreads have to be wider, bigger deals... There just might not be room for bigger deals. I'm rambling a little bit. I'll turn it over to you.

Chris: I think it might be the case that this is my lightest merger arb exposure ever or in 15 years, something like that. And one of the issues is that, I'm indifferent between the probability of deal gets done, what I'm mostly concerned about how variant my view is. But it has to be analyzable. Everything we look at has to be legal and analyzable. And on the analyzable side, the administration is willing and they're very clearly enunciated. They're whole government theory of this thing, which is, if anybody has any power to do anything, we're supposed to be all pulling for our team and our ideological preference in the statutory jurisdiction doesn't really matter to them. We saw this in TEGNA with how the FCC manipulated the process. We're seeing it now in Frontier with the Department of Transportation.

And it really cuts deeply into the rule of law and due process and the ability to have your day in court in front of a judge to win or lose. And it makes the American system much more like Europe. And we're seeing it in this administration in a progressive direction. Boy, I thought the suit... I thought the antitrust suit was actually fairly convincing and likely a winner and had everything they wanted. So it was customer-facing, it was low-end customer facing, it was ethnic low-end customer facing. It was just everything from that progressive political perspective that they would like to be able to say. I thought the likelihood that they were going to file was very, very high. And the likelihood they're going to want to settle it right away is very, very low.

And in the antitrust, this is an industry where they have more than no point. And this is an industry with prior price fixing. And there's lots of hot docs. There's hot, hot docs here. So this is what they love. And the DOT coming in is gilding to Lilly. We have such a winning political case. The ambitious DOT secretary said, "I want to come in on this one too." But if they could probably kill this one without that. But no, it makes it very hard to have a back and forth, to have a settlement and to get in front of a judge and win cases that deserve to win. So I think this deal's probably doomed and my ability to analyze it with any kind of confidence is almost as doomed.

Andrew: One thing that surprised me here. I think we talked about the Spirit deal back when it was the Spirit Frontier deal, and then JetBlue came over the top. And one thing that surprised me is Spirit literally published presentations that said, "Hey, if JetBlue buys us, this is going to be a regulatory problem." And then JetBlue already was fighting the DOJ on their Northeastern alliance deal and JetBlue despite the target publishing things that said, this is an antitrust problem, despite the DOJ clearly saying it's an antitrust problem if you buy anything, JetBlue just ram rotted through here. They just kept coming, kept coming until Spirit eventually had to say yes or also would've been a fiduciary problem. And I think their shareholders were saying, hey, they're offering to pay huge rate fees, all this sort of stuff. I just wondered, these are big companies. They're supposedly have the best advice. How do they get in a situation where it seems so clear to you and me that this was going to be a regulatory problem? How do they get in a situation where they were in this regulatory issue?

Chris: And the complaint just wrote itself. I think it's really hard to fight a battle beyond the battle you're in when it's competitive and emotional and all of the people involved are trying to win in their pot, committed on decisions that they made, and they think they're right. So you throw all the ammo you have at that current fight, including ammo that's wildly counterproductive where the next battle you're going to be in. You figure out just I'll fight that battle when I get to it. But in this case, it was glaring and the government used it to good effect. I really thought about both in the save complaint and in the CFTCs complaint [inaudible]. The one thing the government's really, really damn good at is getting their hands on every document that they want. Probably US, especially because of all of our national security apparatus, we're just really good at signal intercepts and tracking down the information they want from internal docs, including when people don't want to be repeated. It's almost funny when you read these complaints and somebody's whispering, like, I hope they don't notice this and such and you're reading it on page 20 of the complaint. Big yikes.

Andrew: It's like on a TV show when the guys or the criminals are talking and the cops are in the other room listening. They're like, this is gold. That's literally what's happening with these guys. You can correct me if you feel differently here. I get lots of inbounds on spirit, and they're like, hey, if JetBlue can pull this off, I can't remember what the exact consideration would be, but it's a lot higher. Spirit is trading for about $16.70 right now. If JetBlue can pull this off, stock is going a lot higher. You get a huge arb. And then if they can't, Spirit is trading for their tangible book value is about $14 per share, they're going to get a little bit of breakup fee, maybe they could revisit the Frontier merger, or just as a standalone, it looks cheap. It's a brainer to me. I don't see a way this deal's going through at this point, and I get the objective cheapness, but I look at it, I'm like, this is the airline industry, man. I'm not sure I want to get into the business and the airline industry. And it's just a brainer to me. I'm just not sure I've got any real analyzable edge there, but I know it sometimes bounce on it

Chris: Yeah. No position, not a lot of interest in it. I understand the point. But arbs tend to be such sloppy sellers. I think usually there's a later lower opportunity. So we'll see. One of the things that struck me reading the complaint, thinking about Frontier in particular and it's really a creature of the fact that most customers just shop for plane tickets on price only, and that's how they shop. It's not what they're grateful for once they're halfway across an ocean on one of these planes. But Frontier is a fairly a miserable experience to fly on. And the complaint goes into all of the details that if JetBlue buys them, they're going to rip some seat outs, they're going to format it just like JetBlue, and that that's going to be this terrible thing. And there's just something philosophically funny about antitrust, at least how in this case it's being used not just for price, but for qualitative concerns about a market, which is neither you nor I offer to fly people extremely inexpensively to Puerto Rico or somewhere. Why is it that this guy who temporarily was willing to do so, but wanted to stop doing so at some point in the future, he has this... He's like this second-class citizen that is unlike you or me is required to keeping doing the thing that he's already doing. It seems like this very strange duty that you could say, yeah, I did this for a while. I don't want to anymore. They're willing to buy it, they're going to make it more like they're planes and I'm undone.

It's a strange phenomenon for me that they have to keep going the way... And antitrust has this impact on how an industry is organized that is always very lowercase c, conservative in the sense of, I'm looking at how things are right now. I'm going to step in and say, now's the perfect time. Now is what needs to be defended. Not yesterday, not tomorrow. And not allow for the natural evolution of an industry. I'm going to simply put my foot down and say, yes, this is good. When I look at a Spirit flight, it doesn't look that good to me. And it's interesting that the government wants to very specifically defend that, including the qualitative aspects of this one airline.

Andrew: The reverse would just be very funny. If you and I launched an airline that was, hey, if you're going to Puerto Rico, we're going to charge $30,000 per passenger, but it's going to be laddish man. We're throwing in king-size beds instead of seats and you can get anything you want. And three years to now we're like, we got to sell. JetBlue figured out they will make a lot more money if they take our planes and they just convert them to normal planes. And then the department of... The DOJ came after us was like, absolutely not. If you sell to JetBlue and you let them fly normal middle-class Americans over there at reasonable rates, it's going to be impinging on the $30,000 per flight travels. Last one I quickly want to say. Activision Blizzard. We talk about it basically every time. It's because it's the biggest merger or about there. Look, it's been a rough market month for the stock market. It's been a good month for Activision Blizzard. I'm kicking myself because I think we started getting a little more bullish in the last one. But this month the CMA came out. There's been rumors EU basically, it seems like the CMA and the EU are about to... Microsoft's going to give them a little bit, maybe not a pound of flesh, maybe they're just going to give them a cup of sugar, but it seems like they're going to drop. And then Activision Blizzard, seems like they're going to have the US antitrust case, but it seems like a lot of those concerns where you and I, for months, we've been saying, I just don't know how you get around the UKCMA. If the UKCMA wants to block it, it seems like UKCMA is going to drop and then we've just got a normal answer case. I just want to turn it over to you. How are you thinking about Activision Blizzard these days?

Chris: It's a huge step forward to make progress with the CMA. It looks as if they are... They said something explicitly and then there's an implicit aspect to this. Explicitly they are narrowing their review and they are not going to go after them on consoles, but implicitly they're not carrying water for the US. And if that's the case, and if these can be handled independently, it would be a big win to get CMA in a year, again, in front of a judge in the US. They just, by the way, got Japan, wasn't a big focus, but they're rolling up the other external reviews. Microsoft has dealt with this extremely well. They have some really great executives and they have some really great lawyers on this. And so this has been a big step forward.

By the way, people who are interested in this deal should follow if anybody doesn't follow Meservey, Lulu Cheng Meservey is just a sensationally good PR corporate comms person at Activision and unlike any comms person I've ever seen in terms of how mouthy she is on antitrust in particular. But she has a substack really, really, really good at Activision. But I think we're going to... If this is dealt with on the merits with a due process in the US, I think the companies will wipe the floor with the government. The risk has always been that they're clever and they get coordinated action with the EU or with the CMA. And we're not out of the woods yet, but that's looking a lot better. So I think we probably have passed over from under 50-50 to over 50-50 that they can get this done.

Andrew: Let's say EU, UK, everything, what's the timing of the trial? It's early August is when the trial would happen, and then I guess we'd get a ruling in what call it November. Am I thinking about that correctly?

Chris: Yeah, I think April, May we would know we're heading to the US court and that's really where this is going to be determined. Yeah, summer trial, fall, winter wrapping up, and then with some prospect of settlement or acceleration before then.

Andrew: Yeah. Okay. That makes sense. So I guess the two things, if people are thinking, so I'm pretty sure the trial starts early August, so if people are wondering when we won't be talking about the largest merger arb out there, by the end of the year, it seems like it'll be done for sure. But it's just interesting to me because the other thing, and I've made this point in the podcast before, but right now with all the positive UK and EU stuff, I've even started seeing people be like, "Hey, Activision would love to get out of this deal." Maybe it's time for Microsoft to bump on this deal as the timing goes, because Activision appears to be performing really well all of a sudden. I think people think of their big games, but they also own King, which has Candy Crush.

Candy Crush somehow is still wildly popular. It's growing revenue really well. Activision's new game, Diablo IV. Diablo is one of my favorite games when I was a very little kid. But Diablo IV is getting great reviews. It's tracking to be one of the biggest games of the year, of the past multiple years. It's getting unbelievable reviews. So all of a sudden Activision is performing really well and people are saying, bump, fundamental downside keeps coming higher and higher. And I get all of that. But I also would just point to you, if we were talking about this a year ago, we would've said Activision is a broken company. Engineers are fleeing left and right. The performance is dismal. To me, it's just the fundamental value of a video game company is very hard to do. If you're talking about buying it 20 times price earnings, that means you need 20 years of earnings to make up your fair value.

These things can swing really wildly. I don't know what platforms we're going to be playing. I don't know what people are going to be into. I just think it's very hard, a little bit similar to movie studios. Yeah, movie studios have value. A lot of the values in the library and the relationships and stuff, but when they go to strategic buyers, they tend to go for a lot. But in the public markets, it tends to be really hard to capitalize them. And I do think there's something to that with Activision. But anyway, anything else you want to talk about Activision?

Chris: Yeah. One last thought I have is, I keep trying to think about this deal from a Sony perspective and if it looks like Microsoft is making good progress right now towards resolution of CMA and EU, does Sony have the point of maximum leverage now? Because for all the reasons that I think this deal would be hugely benefited by getting in front of a real judge in the US and hashing it out with econometrics and with data where I think they have hugely... I think other than politics and shenanigans, I think Microsoft has hugely the upper hand here. If that's approximately right and Sony has some very good lawyers do they try to cut a better deal now? Because if the government loses Sony as a complainer, then that just obliterates their case. That takes the deal from... Because say the deal just went from 45% to 55% chance it could leap from 55% to 75% chance just with Sony saying we love it, we're set.

Andrew: Did you see yesterday, I think like 17 Senators, Congressmen sent a letter that said, "Hey, we're worried that Sony is unfairly hurting the Xbox in Japan in violation of the US-Japan free trade agreements.

Chris: Yeah.

Andrew: I was wondering if that was because I think a bunch of the senators are from areas where Microsoft has a lot of pool and I was wondering if this is Microsoft. Obviously, there's a difference between saying, hey, maybe there's unfair practices in Japan versus pulling up an almost $100 billion merger. But I was wondering if this was Microsoft trying to exert a little pressure somewhere else to get Sony to come to the table on this particular deal. But yeah, anything else you want to talk about with Microsoft Acquisition?

Chris: No. I think that's pretty good.

Andrew: Whew. Well, Chris, I said I was joking up front when I said I don't know what to talk about, but whew, this was a wild month. Who knows where it goes? I'm hoping April is much smoother sailing. We'll have a shorter podcast with much less potential banking crisis to talk about, but this was great. We'll talk before then, but we'll do a podcast in April, and looking forward to that one.

Chris: I'm looking forward to it too. Thanks, Andrew.

Andrew: Perfect.

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