June 14, 2023 - Bankers Anonymous

June 14, 2023June 14, 2023

Is Rackspace Officially Dead?

It’s hard to overstate the importance Rackspace played in San Antonio’s imagination about itself in the year 2009, when I first arrived in town. A scrappy mid-sized technology company, launched by 3 college kids in their proverbial dorm room, had established an early-mover advantage in the growing technology service known as cloud hosting, and was using that advantage to fend off the biggest names in tech: Amazon, Microsoft, and Google. With the cult slogan “Fanatical Support,” hopefuls wondered if Rackspace could do for San Antonio what Dell had done for Austin. Would rackers overmatch the difficult competition and transform sleepy Alamo city into a tech hub?

The relentless, one-way drop in RXT shares from $20 two years ago to just over $2 shares as of this writing tells us that David did not, in fact, slay Goliath. The stock’s chart over the last two years is just a Matterhorn-shaped downward slope with no bottom in sight.

The equity market capitalization dropped in that period from $4 billion to around $250 million by mid-May 2023, approaching one-twentieth of its former size. Looking at that kind of chart in May I naturally ask the fundamental question: “Is Rackspace dead?” And also the technical question, “what the heck is wrong with RXT shares?”

Now, here I want to distinguish between a company and its shares. A good company can be a bad stock investment. And in certain instances a bad company can be a good stock investment. And everything in between. I will mostly save the judgment about whether Rackspace is a good company with good long-term prospects, “the fundamentals,” for a future column. Today I mostly want to discuss “the technicals,” which addresses the question “What the heck is wrong with the stock?” rather than the more profound question of business prospects.

Still, we’ll do 3 sentences on the fundamentals, and then the rest of the column on the specific technical issues that may have plagued RXT, the stock, for the past two years, and in particular the last few months. And then a technical change in stock market plumbing announced last month that reflects RXT’s changed prospects.

The Fundamentals

RXT reported a loss of $612 million for the quarter ending March 2023, following a full year loss in 2022 of $805 million, on $759 million in quarterly and $3.1 billion in annual revenue, respectively.

As of March 2023, the company reports $3.3 billion in long-term debt at an average of 5.5 percent, not due until 2028, giving it attractively-priced debt service, and a runway of 5 years before it needs to refinance the debt.

Cloud computing services, as an industry, are projected to grow between 15 and 20 percent annually for the next 5 years, so an experienced provider that merely maintains market share with the natural tailwinds of the industry could be positioned to grow nicely.

Fundamentally, we have 5 years to find out whether Rackspace is dead.

The Technicals

So then what technical forces are crushing RXT, the stock, these past 2 years?

Technical analysis seeks to explain the current and future price movements of a stock according to the supply and demand dynamics specific to the stock. This is distinct from studying the fundamental revenue, cost, debt, and cash flows of the business itself, as we did above.

The largest holder of RXT remains private equity firm Apollo Global Management with 61 percent of the company’s shares. In 2016 Apollo took the company RAX private from the New York Stock exchange. Apollo then relaunched Rackspace via IPO under the ticker RXT in August 2020 on the tech-oriented Nasdaq. In part because Apollo still owns most shares, the supply of tradable shares, or “float,” is quite small. Very few individual, or “retail” investors own any shares.

The volume of share transactions in RXT has declined over the past year, along with the stock price. A year ago between $5 and $8 million worth of shares traded hands per day. That has slowed to an average of less than $2 million per day over the past two months.

A low “float” of the shares, the declining dollar amount of trading, and a price approaching $1 per share all tend to further depress interest in a stock among professional investors.

Non-Apollo shares are mostly owned by Small Capitalization Index Mutual funds. My strong belief is that this particular fact is the absolute key to understanding the one-way price movement of RXT over the past months.

The top mutual fund holders of RXT are all ETFs and index funds, from Vanguard, iShares Russell, and Fidelity. RXT shares are also held in some “technology,” and “total market” index funds.

A major technical problem for RXT of this ownership is that each of these indexes is “market-weighted.” This means that as the market capitalization of the company drops, the automatic weighting of the company within that index drops. That makes the indexes forced sellers of the company’s shares as prices decline, in a self-reinforcing vicious cycle.

In theory, and as often happens with other stocks, institutional value investors (non-index investor) sometimes jump in to purchase shares in this scenario, which helps to break the vicious cycle. But for most value investors RXT’s float is too small, the trading volume is too small, and most importantly, value investors don’t love annual losses larger than the market capitalization of the company. So far they’ve stayed away.

But I suspect the biggest problem with RXT is the specifics of the Russell 2000 index that happened last month, which determines ownership of small capitalization index funds.

The Russell 2000 index is comprised of US small-capitalization companies, in particular those ranked numbers 1,000 through 3,000 on the list of US companies, by size.

As of 2022, the literally smallest Russell 2000 index company – the 3,000th ranked company on the list – had a total market cap of $240.1 million. Interestingly, RXT breached that bottom floor of market capitalization last month.

The Russell 2000 index makers set April 28th 2023 as the annual cut-off date for determining who is in or out of the index. On that date, RXT had an approximate market capitalization of $320 million. This put RXT on the bubble of being dropped by the Russell 2000 index. The result of that would be further forced selling by the index holders.

New IPOs allow companies to be added quarterly. Other additions or subtractions due to growth, merger, or shrinkage happen just once a year. Companies are subtracted from the Russell 2000 index on an annual basis, and May 19th was the announcement date for whether RXT would remain in the index.

Let me not hold you in further suspense. Despite being on the bubble, RXT did not get dropped from the Russell 2000. The size of the smallest company to remain on the Russell 2000 list dropped to $159.5 million in 2023, 33 percent below the previous floor. RXT was saved in a sense because the standards for inclusion got easier!

RXT actually got added to the Russell Microcap Index for the first time on May 19 2023, the index for even smaller companies with a market capitalization going all the way down to $30 million.

But even though they were not removed from the Russell 2000 list this year, the risk of subtraction from the index, plus the vicious cycle of lower prices leading to lower market weighting, could explain much of the past few months’ price action in RXT.

Getting put on the Russell Microcap Index is somewhat analogous to relegation to a single-A baseball league down from the triple-A league where it had previously played. The stock may take a long time to ever attract major league investors. Or it may never again attract them.

Languishing in obscurity is ok for profitable companies that can put together a good fundamental track record of profit over time. It could get back on the list and in that sense be eligible again for the majors. For a company with $3 billion in debt due in 5 years, and a string of annual losses, it may be a harder slog. Time will tell.

A version of this ran in the San Antonio Express News and the Houston Chronicle

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June 14, 2023June 14, 2023

Higher Education Philanthropy Priorities

April’s big higher education philanthropy news left me grumpy. I mean, yes, it’s nice that financier Ken Griffin has pledged a gift of $300 million to Harvard University. In exchange Harvard will rename its Graduate School the “Kenneth C. Griffin Graduate School of Arts and Sciences.” Higher education is good, philanthropy is good, and Harvard is good. It should be all good.

Still, here’s why I’m grumpy. Harvard is the least worthy use of hundreds of millions of philanthropic education dollars I can possibly think of. They need it the least.

Among universities, Harvard already boasts the largest endowment of any university. With $50 billion under management, cynics (like me) have long quipped that Harvard is a world-class hedge fund with a fine educational institution attached to it.

Harvard does not really elevate learning in our larger society, except in the most extreme trickle-down kind of way. The profile of a student actually boosted by Griffin’s donation is extremely narrowly selected. A $300 million gift seems like a bizarre over-allocation of resources to people for whom resources are truly not scarce.

Among 4-year colleges, Harvard is already quite generous with families of demonstrated financial need. But these students admitted from low socioeconomic strata are extremely few. The path into Harvard is so narrow that only rarely does a student from a lower-income family gain admittance. Second, these narrowly selected students – rich, poor, or middle class – probably would thrive wherever they went. Third, most of Harvard is made up of students from relatively privileged backgrounds, making the institution far less impactful on society as a whole, when considering it as a recipient of philanthropy.

Griffin giving $300 million to Harvard helps an organization that doesn’t need it, which in turn serves mostly students who largely don’t need it, or students who would succeed without it.

What Ken Griffin mostly bought for his $300 million was naming-rights as a monument to himself in perpetuity, burnishing his own reputation as a “success,” via brand-affiliation with Harvard. A personal monument and a name brand. It’s Griffin’s money and he gets to prioritize what he wants. But the gift just struck me as the worst kind of higher-education philanthropy.

Meanwhile, the contrast with the very best in higher education philanthropy is very stark.

In the midst of the pandemic in 2020 and 2021 MacKenzie Scott – author, philanthropist and via divorce from Jeff Bezos a 4 percent owner of Amazon – set a new and better standard for higher education philanthropy. Scott’s lessons were ones that Griffin either didn’t notice or chose to not learn.

She gave billions in total to organizations vetted for accomplishing great work but that suffer from insufficient resources. The opposite of Harvard in terms of need. She gave to hundreds of organizations that actually needed the money.

She thoughtfully targeted institutions – like Big Brother Big Sister, or community colleges, that serve a broad and inclusive swath of people who themselves had insufficient resources. Again, the opposite of Harvard. People who actually needed the support.

Because social and economic class is self-reinforcing (in contrast to our national myth of social mobility) higher status and more selective higher education institutions matriculate students from higher income families, on average. Also, higher status and more selective institutions generally cost more. As a result, if you want to help social mobility through increasing educational opportunity, the place to focus is regional and community colleges. So that’s what Scott did. That’s where the transformation in people’s lives and in society is likely to take place.

At Harvard, less than 12 percent of students come from the bottom 40 percent of households by income. A larger cohort at Harvard, 15 percent of students, come from the top 1 percent of households by income. All of this is according to research done by Harvard’s own Raj Chetty and a team of economists.

At UT Austin, 15 percent of students come from the bottom 40 percent of households by income. Which itself is a result of its highly selective status. At UT San Antonio, 26 percent of students come from the bottom 40 percent of households by income.

In Bexar County’s Alamo Colleges, 43 percent of students come from the bottom 40 percent of households by income. So that’s where Scott gave. Where the students with the most financial need are actually studying.

The socioeconomic origin of families of students is just one measure – but an important one – of the role higher education does, or does not play, in creating pathways to social mobility.

For all of Harvard’s successes in championing lower socioeconomic access to higher education – a pitch made with just about every alumni solicitation for donations that it sends out – a much more effective way to support this cause would be to donate to higher education institutions that truly serve middle and lower-income families. Like community colleges, or public universities that serve a region or state.

In San Antonio, Scott gave $20 million to San Antonio College, and $15 million to Palo Alto College, both part of the Alamo Colleges District.

Dr. Mike Flores, Chancellor of the Alamo Colleges District, admires Scott’s philosophy of giving to under-resourced communities. Further, Scott allows the recipient institutions full discretion in how to best spend her gifts.

Scott’s donations went into programs such as $4 million to support students in high-demand degrees in tech or nursing that will likely transform their lifetime economic prospects for the better. $5 million went toward the $75 million endowment for AlamoPROMISE, which provides scholarships to make an Associates degree affordable for most area high school students.

I think what MacKenzie Scott got for her $25 million to Alamo Colleges was life-transforming social mobility among people who need it most. And they didn’t name anything after her. She doesn’t really get bragging rights through brand affiliation with a community college. Instead she just gets to make a difference.

A huge priority for Alamo Colleges is to make sure any area high school graduate can get free or greatly subsidized tuition, with wrap-around services, on the way to getting an Associates degree, what Dr. Flores deems the “moonshot” program known as AlamoPROMISE.

Dr. Flores, when asked how he thinks about transformational gifts in higher education, “Just imagine, an $80 million dollar gift could guarantee graduating high school seniors access to AlamoPROMISE in perpetuity for Bexar County graduates for decades.”

Scott didn’t build a monument to herself when she gave her gifts, but she demonstrated a far better philanthropic model than the old one Griffin followed this month.

Harvard is not a bad institution. It represents greatness in many fields and is a cool place for a fortunate few. As a destination for philanthropic dollars, I just would personally place it last on my list.

Disclosure: In 2022 I offered consulting services – online personal finance lessons – for employees of the Alamo Colleges District.

A version of this ran in the San Antonio Express News and the Houston Chronicle

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June 14, 2023June 14, 2023

Book Review: The Psychology of Money by Morgan Housel

In 2020, the best living writer on personal finance published his first book. (No, I don’t mean me, silly. You are just too kind, stop it, I’m blushing.)

Morgan Housel wrote The Psychology of Money: Timeless Lessons on Wealth, Greed, and Happiness and, of course, I had pre-ordered it from Amazon and yeah, you should read it.

If you’ve already read dozens of personal finance books (I have!) then I’m not saying you must read this one. But you will be entertained, and you will finish it in less than a day. If you haven’t read many personal finance books before, then this is a really good place to start. And if you haven’t specifically read Morgan Housel before then you are in for a treat.

Each chapter tackles a key aspect of wealth-building. I particularly enjoyed his chapters on wealth, risk-aversion, and narrative bias.

Wealth is not achieved by owning a bunch of expensive stuff. The fast cars, the big houses, the fancy electronics. We often believe people who have those things must be wealthy. Maybe they are, or maybe they just have an appetite for debt. Without checking their bank statements, we usually don’t know. Wealth, Housel argues – I heartily agree – is better measured in terms of freedom. Freedom to spend your day just as you choose, wherever you want, with whomever you want.

Importantly, a pile of money in the bank can be quite helpful in obtaining that freedom. But equally true, vastly different amounts of money enables emancipation from obligation, depending on the size of one’s wants.

To the extent the expensive stuff actually diminishes your available pile of money necessary for freedom from obligation, it’s not a stretch to understand that the car, house, and electronics may actually result in less wealth, not more. Wealth, Housel reminds us, is achieved through what you don’t buy. Readers familiar with the classic finance book The Millionaire Next Door will recognize this whole thought process.

Here’s another great point Housel makes. In investing, the price for good returns is often volatility and uncertainty. If you can’t handle either volatility or uncertainty, you can’t afford to be in assets that provide a good return. Most people, it turns out, can’t really pay that price. In behavioral finance, we talk about the related idea of asymmetric risk aversion. This means we suffer from losses much more acutely than we enjoy gains. We focus on the bad and have trouble tracking the good. A pessimistic worldview holds our attention and feels “realistic” while an optimistic worldview feels “unserious” or “unreliable.” Newspapers know this, as captured by the cliche “If it bleeds, it leads.”

Nobel-prize winner Daniel Kahneman suggests this focus on the negative over the positive had evolutionary roots, “This asymmetry between the power of positive and negative expectations or experiences has an evolutionary history. Organisms that treat threats as more urgent than opportunities have a better chance to survive and reproduce.”

Unfortunately, this explains why most people can’t handle the advice to “buy and hold” stocks for multiple decades, despite overwhelming evidence that this is the right way to go.

Like other accessible finance writers, Housel relies on narrative and anecdotes to illustrate his timeless lessons. You will recognize familiar heroes and villains from these stories of wealth and greed, such as Warren Buffett and Bill Gates, Bernie Madoff and Rajat Gupta.

As an improvement on the familiar, Housel devotes a chapter to how narrative can deceive as well as illuminate, when it comes to investing. Behavioral finance teaches us that in the face of uncertainty – and investing is always uncertain – our brains tend to tell us stories that make us feel less uncertain, even when that’s unwarranted. Once we become attached to a certain story – this company always beats its earnings, that industry is crumbling, this entrepreneur achieves engineering wizardry on a regular basis – we disregard the data that doesn’t reinforce our pre-set narrative. We do this in our relationships, in our personal identity, and in our politics. Housel warns that it can be an expensive tendency to stick to the same preconceived narrative in investing.

One of the most pleasing parts of finishing The Psychology of Money, to me, is that Housel eventually says in the penultimate chapter what he does with his own money and investment portfolio.

If you always wondered what a careful money knower does with his own money, you may be similarly interested in that question and his answer.

Readers of my stuff over the years will already know how I answer that question. But if you don’t yet know, I am pleased to report that Housel does exactly what I think the right answer is. So you can read his, and my, answer for yourself, in Chapter 20.

But of course we should consider the implicit possibility, which I now make explicit, that maybe I appreciate and celebrate Housel because his narrative about money and investing closely matches my own narrative about money and investing? Perhaps I have fallen prey to the very same confirmation bias that behavioral finance warns us against? Gosh, it’s all so meta.

Addendum

Quick addendum about the best living finance writers. In 2020, The New York Times wrote up a feature on the second-best living finance writer, Matt Levine

Levine writes a column for Bloomberg News called “Money Stuff,” available for free as a daily email. Everyone should subscribe.

He is intellectual, hilarious, and produces in-depth, annotated daily explainers about Wall Street from a guy who used to work on Wall Street, respects the game, revels in the complexity, but who also sees the irony and humor in it all. Levine is like me, but five times as good.

Thankfully the competition is still open for third-best living writer on finance. I’m reserving a spot on my mantle for the bronze medal. So, please, get all your ballots in on time. Is that not what this election chatter I’ve been hearing is all about?

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