No Surprise Retail Traders Lose on Facebook IPO

     Facebook's IPO has been criticized roundly, and the lawsuits are now starting to fly.  In the days leading up to the offering, both the amount of shares being sold and the offering price were increased significantly.  While this might make sense on the back of some good news about Facebook, the only recent developments in their business were negative: the difficulty in monetizing mobile, slowing growth, and a quarter over quarter revenue decrease.  Of course, given the unbridled optimism and enthusiasm some people have for Facebook, the IPO might have succeeded in spite of such warning signs.  I assume that is what the underwriters were hoping for.

     Not only was demand lacking above, or possibly even at, the IPO price, significant problems with NASDAQ's handling of trades caused delays and unconfirmed trades left and right.  The media pointed out that some analysts for underwriters such as Morgan Stanley had communicated misgivings about Facebook's IPO valuation to important clients of the firms.  This is an area of legal contention, but it seems that there is likely nothing technically illegal that occurred during the week of the IPO; analysts may have been allowed to share new opinions verbally without running afoul of disclosure rules. 
   
     This brings us to my favorite complaint heard throughout the coverage of Facebook: the IPO showed how Wall Street wasn't fair to the little guy because of information sophisticated investors might have been privy to compared to your retail John Doe.  The naivete of the assumption that Wall Street should be "fair" in this regard is astounding.  Of course a retail trader doesn't have as much information as financial professionals; they never do. 

     Regardless of whether or not analysts involved in the IPO may have quietly revised price targets down or expressed concerns to clients, retail guys don't have the same knowledge and understanding of Facebook's finances nor analyst research.  Even the most well-informed retail traders who can break down accounting statements and dissect a stock's story don't have access to the amount and depth of analyst research that professionals do unless the retail investor is willing to pay large sums for it.  Just because an analyst might have disclosed their new opinion on a stock doesn't mean John Doe ever sees this report.  It isn't free disclosure. 

     Retail traders also don't have the market knowledge of professionals who spend every day around the markets and are plugged in.  Is the rumor across trading floors that this IPO price will have a hard time being justifiable?  What kind of volumes and order flow are coming across the tape right now?  What are the derivatives markets telling us, and how will external or global events effect prices today? Most retail guys wouldn't know, as they don't have access to such information flow. 

     So, your average individual who traded this IPO doesn't understand the business all that well and doesn't have the market knowledge to see warning signs about a lack of price support or interest if such signs did exist.  And people are upset and surprised they lost money?  I'm more surprised John Doe ever makes money on a trade, but I chalk that up to the laws of probability.

Mail-Equivalent Reimbursement - A Disruptive Approach for Retail Pharmacies vs PBMs

An injunction to stop the Express Scripts-Medco merger, requested by the NACDS, NCPA, and some  other assorted individual pharmacies, was tossed out in April.  The lawsuit continues, but the plaintiffs can't be optimistic.  Retail pharmacy is worried, as an industry, by the merger.  Pharmacy benefit managers, or PBMs, manage the pharmacy benefit for employers or health insurers, processing claims, contracting with pharmacies, and negotiating with manufacturers for rebates.  The story goes that, by having a knowledgeable middleman who can squeeze discounts from pharmacies and rebates from pharma, the payer, whether it is an employer or insurer, saves money.  The deal between Express Scripts (ESRX) and Medco (MHS) consolidates and increases negotiating power of PBMs over pharmacies even further; together the two will handle a little over a third of all the prescriptions processed in the U.S.  In addition, Express Scripts and Medco both operate massive mail-order pharmacy operations, contributing a significant percentage of both firms' revenues.  The current trend of PBMs encouraging, or requiring, members to use mail-order for chronic medications further threatens retail pharmacies profitability, and the industry is justifiably worried that the combined ESRX/MHS company will become even more aggressive in pushing their mail-order business.

From a payer perspective, the argument for mail order makes sense; the same prescription can typically be filled at a lower cost to them than at a brick and mortar pharmacy.  So, plan sponsors save money when the members receive their meds through the mail.  From a PBM perspective, filling the prescription via mail order captures the prescription revenue completely instead of flowing to a retail pharmacy.  Of course, from a retail pharmacy perspective, you're simply losing business to a competitor who doesn't have to operate physical stores. 

Retail pharmacy has fretted publicly about the loss of the patient relationship with their pharmacist when mail order is required.  This tactic won't convince those footing the bill however.  For retail pharmacies to attempt to stem or reverse  mandatory mail order, the argument must focus on the payer.  It is the plan sponsor who is the client of the PBM, and it is the plan sponsor who agreed to the benefit arrangement that allowed or required mandatory mail-order to save money in the first place.  Retail pharmacies should offer to accept mail-equivalent reimbursement; the same amount the plan sponsor pays the PBM for a mail order prescription should be offered to the retail pharmacy to accept or decline once a prescription would be required or incentivized to be filled via mail-order. 

Under such an arrangement, if the retail pharmacy contracts to accept mail-equivalent reimbursement, the PBM would simply continue its function of processing claims, paying the pharmacy, and billing the plan sponsor client.  The plan sponsors still save money, members have more choices in how they receive their prescriptions, and the ancillary benefits of regular contact with the pharmacist are maintained.  Pharmacies would have to determine whether the lower reimbursement is worth it, but it certainly would be for some.  This appeal has to be to payers, as PBMs have little incentive to surrender mail-order revenue.  If retail pharmacy can present this approach to payers as a three pronged argument, helping keep costs in line while increasing access and helping focus on patient care, then PBMs will not have much of a counter-argument.  Mail-equivalent reimbursement could be the new paradigm the industry needs to avoid large shifts in prescription volume to mail-order. 

5 Points on the Regulatory Fallout from JPMorgan's Trading Losses

As the news of JP Morgan’s trading losses continues to reverberate around the web, (check out http://www.usnews.com/news/articles/2012/05/11/in-jp-morgan-loss-bank-regulation-advocates-see-opportunity for an overview of why there is continued debate) here are five key takeaways that I think are mostly missing from the coverage:

1. Many people are speculating that the hedge was a “bet,” which I guess is critical parlance for subversive gambling of some kind.  However, there doesn’t seem to be any reason to not believe JPMorgan CEO Jamie Dimon’s statement that the position was a hedge.  It sounds like the trade was meant to hedge some macro exposure the bank’s risk officers felt they had, and the trade went awry.

2. Any business involved in the financial markets can have individual risk exposures from a single trade, asset, or business dealing, but the risk of the firm can also be looked at as the net exposures of the collective transactions.  Even if you try to completely hedge every individual transaction, that won’t typically be feasible; thus you have net exposures from the sum of all of your individual risks.  

3. If you don’t allow banks to look at their portfolio, assess the risk from it and their other business lines, and subsequently choose whether or not to attempt to hedge to reduce that risk, you actually increase the likelihood of the bank failing (the opposite intended effect of Dodd-Frank and the Volcker rule) as you have taken away a risk management tool. 

4. Though I certainly have not read the ~850 odd pages of Dodd-Frank, I am under the impression that the rules currently proposed would allow for macro hedging, such as hedging of business risks not associated with single assets.  Thus, it would seem that JPMorgan’s trade wouldn’t be illegal.  Even if the regulations end up attempting to tie hedges to specific holdings, I would think any enterprising bank could still argue for trades that act as macro hedges by pointing at assets in their vast investment portfolio.  Of course, taken further, practically any trade a bank desires could be justified.  And that’s what you get when you try to regulate something so complex.

5. It may be nigh impossible, and will almost certainly be a waste of time and money, for regulators to concoct a definition for hedging that would be as effective or constraining as they would like.  Even in a single, simple transaction, such as a derivative sold by a bank such as JPMorgan to an investment fund, the bank will likely have resulting exposure to the underlying assets, volatility, interest rates, time, and the other variables derivatives depend on.  Will regulators be able to tell banks how, how much, and how often they should hedge each of these risks in their quest to eliminate prop trading?  How will a regulator, who almost certainly will understand the assets less than the bank, determine whether a transaction is over or under-hedged and thus has exposure that might be considered “prop?”  Congressman Frank and Senator Levin would have people believe that Dodd-Frank, and the Volcker rule in particular, are going to help the country by reducing risk and avoiding any more bank meltdowns.  Looks to me like the winners right now are financial services lawyers and lobbyists.