The main story on the capital markets page of the FT today was titled: “World Cup offers investors a sporting chance”
It’s a big question for many large companies but most sports fans do not care. Does commercial sponsorship of big sporting events yield any benefits to the corporations who are doing it?
Official sponsors of this year’s soccer World Cup in Germany have paid up to €45m each for the privilege of becoming an official partner of the tournament and seeing their names beamed into billions of television sets around the world for a month.
The article describes a structured principle-protected basket equity-linked note that is designed to pay-out or outperform if the shares in companies who are major sponsors of this summer’s soccer World Cup in Germany outperform their peers. The investment thesis is that the boost to their respective businesses on the back of the exposure afforded them through their sponsorship of this event will trickle down to their bottom line and ultimately to their share price.
Assuming that today the relative prices of the ‘sponsors’ vs their ‘peers’ is appropriate, and that the share price will indeed be positively correlated with the amount of ‘exposure’ the company gets during the World Cup, then surely the sponsor companies (and the investors in these notes) are exposed to what I will call the ‘eyeball value’ of the tournament. I don’t have a formula by which to calculate this factor to hand but I know that it is a positive function of who - the favorites, the home team and most populous countries – does well and how, – how many goals are scored and one (not more!) cinderella team in the pools – the tournament plays out.
So the arbitrageur, or hedging sponsor should be able to trade the basis between the basket note described in the article and a basket of bets on the tournament outcome. ie Someone long of the note (or one of the sponsors) would want to lay Germany (ideally at short odds) and the total number of goals. That way if Germany is knocked out before the play-offs and every game is 0-0 or 1-0 – a real snoozefest – they mitigate the lowered effectiveness (‘eyeball value’) of their note (or advertising spend) through their wins on their layer positions.
Algorithmic trading is a hot topic in financial circles these days. Despite it already being a very important and visible phenomenon on Wall Street and the world’s financial markets, in my opinion we are only at the very beginning of what will be a transformational shift in how trading (in all types of markets) is conducted. The market research firm Celent last year predicted a five year compound growth rate of 13% (between 2003 and 2008):
Celent predicts that algorithmic-based equity trading will increase from approximately 14 percent of overall trade volumes to almost 25 percent by 2008, representing a compound growth rate of 13 percent. Traditional buy-side firms, who have thus far been slow to embrace algorithmic trading, represent the industry’s largest growth segment, with a five year compound growth rate of 30 percent.
I think they are low. I think growth in machine or algorithmic trading has entered a period of geometric growth and will see sustained and significant innovation for the next 5 to 10 years. Advances and ideas from areas such as econophysics and artificial intelligence will lead the way:
(From MoneyScience:) Econophysics was started in the late 1990′s by several physicists working in the subfield of statistical mechanics. They spontaneously decided to tackle the complex problems posed by economics, especially by financial markets. Unsatisfied with the traditional explanations of economists (many of which lacked empirical justification) they applied tools and methods from physics – first to try to match financial data sets, and then to explain more general economic phenomena.
(other sites on the subject include Econophysics Forum, Focus Session on Econophysics, American Physical Society, and Didier Sornette, UCLA)
(Thanks to the very interesting Vanilla Put blog for the post on econophysics.)
This rise of algorithmic trading will go hand in hand with the increasing sophistication and scale of electronic exchanges, ECNs and other computerized trading venues.
This is one area however where I would have to admit that the street is not standing still. For instance, just today Bank of America announced its purchase of (selected assets of) Financial Labs:
Financial Labs, LLC was founded in 2003 by a team of Harvard University-educated physicists and astrophysicists with extensive training in computational mathematics, and the managing partners of FX Solutions, one of the major firms in the global retail foreign exchange trading industry. The skills acquired by a scientist in analyzing large data sets and building quantitative models are similar to those needed to identify profitable trading opportunities and fleeting inefficiencies in financial markets; thus, a symbiotic combination of trained scientists with seasoned, professional Wall Street foreign currency traders paved the way for the formation of Financial Labs, LLC.
In a simlar vein, Citigroup acquired Lava Trading in the summer of 2004:
Lava Trading Inc. is an innovative technology firm that develops unique, high-performance trading solutions for the financial services industry. Our products are created as true ASP solutions built to withstand maximum volumes in the most volatile conditions. As a cost effective and neutral provider, our OTC, Listed and Foreign Exchange solutions are used by leading broker/dealers, including most of the top 20 U.S. investment banks, market makers, hedge funds and institutional investors.
The transition to more and more computerised electronic trading will fundamentally alter the financial ecosystem. Like with any significant environmental change, some species will not survive while others – including entirely new ones – will thrive. It creates a great opportunity for both firms and people, but for those unwilling or unable to adapt, the future is bleak.
I would imagine many people in the financial services industry think a mashup is something you do with potatoes or maybe involves bourbon… to be fair however most people actively involved in developing mashups don’t seem to have much interest in banking or securities trading if this site is representative…
(I suppose you’ll be surprised – not! – to find out that) I think this will change. Again the thread connecting finance to the current center of mash attention (media, travel, mapping, etc.) is the fact that it is essentially about data and value is added by organising and representing this data more effectively for the end user. When the “Mashup ecosystem explodes” (David Berlind) (via Doc Searls), I think there is something to be said for being a leader in the financial services space in terms of making your api’s available for mashing.
As an example, this idea (or something similar) over at Vanilla Put is something that would lend itself to a mashup approach.
From FT Digital Business, January 26th, 2005:
“Managers as a whole have not been educated to see intellectual property as an asset in the way that money is,” agrees John Kay, a member of the management group at PA Consulting Group. “If the average company managed its money in the way it managed its IP, it wouldn’t be in business.”
NEW YORK, Jan 27 (Reuters) – New York Stock Exchange Chief Executive John Thain on Friday told CNBC he expects consolidation among exchanges in the next year or two, and he thinks there could be synergies between the United States and Europe.
The NYSE is in the final stages of closing its deal to buy electronic trading company Archipelago Holdings Inc. (AX.P: Quote, Profile, Research), which will turn it into a publicly traded, for-profit company.
Thain, speaking from Davos, Switzerland, said he expected that deal to close a couple of weeks after the regulatory comment period ends on Thursday.
The deal means “we have public shareholders, and we will be responsive to them, and we will operate more efficiently,” Thain said. “But more importantly, we will have a much broader list of products, and as the world of exchanges consolidates, we will be one of the players.”
Over the next year or two, he thinks there will be consolidation in the United States and “across the ocean.”
There could be synergies between the United States and Europe, he said, as a lot of companies trade in both places and there were opportunities on the technology side to share best practices.
I wonder if he’s been watching AmazonBay?
As reported in the TimesOnline, CMC is planning to IPO in the second quarter. The market is speculating on a valuation of between £750 and £800 million, based on approximately 20x average pre-tax earnings for the last three years.
Also IG Index, the UK spread-betting firm that relisted last spring, reported very strong first half results. The current share price values the company at approximately £620 million.
These are companies with users counted in the (low) tens of thousands. The opportunity to expand this business model to a much larger customer base is significant; that said reaching a wider audience would require adapting the specialist business model most of these firms have adopted.
The numbers behind this company underline the scope of the opportunity. As many as 2.5 million people are online playing one of Shanda‘s MMOs at any given time. The scope of their operations is impressive, as described in this November 28th, 2005 FORTUNE magazine article by Stephan Farris:
In another wing sit 300 telephone operators, who field questions from callers 24 hours a day. They are testimony to Chen’s view of the industry. “Online gaming is not a product, it’s a service,” he says. “The first month we got profitable, we invested in the call center.” In another room, technicians monitor real-time digital graphs that track how many users are logged on to Shanda’s games. (The company has a network of 14,000 servers that can accommodate as many as 5.9 million users at once.) “A lot of people think of games as whoever has the hottest product will be the winner,” says Zhou Donglei, head of investor relations. “But it’s really not. It’s who has the most stable platform.” Or, as Chen puts it, “If you want to live in a house, first it should be strong enough. Then we can add the decorations.”
Roger Parloff does an extensive review of the phenomenon of the virtual economies of online games in the November 28th, 2005 edition of FORTUNE:
Whether MMOs (massively multi-player online games) are set in Middle Earth, Camelot, or inter-galactic space, they all have capitalist economies.
He leads off introducing us to someone who makes their living dealing in objects from EverQuest:
It’s a good life and would not be a surprising one for a 33-year-old corporate litigator like Paul, except that he quit his law partnership two years ago. Since then he’s been self-employed at an even more lucrative calling: He plays a medieval-themed online videogame called EverQuest. Because so many young people now spend so much of their lives immersed in the simulated 3-D worlds of games like this one, the noncorporeal emoluments they accumulate in these environments–virtual swords, cloaks, gauntlets, in-game currency, etc.–acquire real value to them, and they will pay real U.S. dollars–and euros, yen, won, and yuan–to acquire them. So Paul buys and sells virtual items and currency for a living. “The valuation is always difficult,” he concedes. “When you think about people paying real cash for something you can’t even touch, smell, taste–that’s tough.”
While it would seem that ‘farming’ is a low-margin business , Castronova calculated a figure for WoW (World of Warcraft) of $1.17 / hour – enough perhaps to enlist workers in some developing countries but not enough to entice someone like Paul to give up his day job…so how did he do it?
“It’s a business model I developed when I didn’t know what a business model was,” Paul says in a clear, confident litigator’s voice. When he was 12, he would buy collections of baseball cards and then sell the cards individually for a profit. Today Paul buys EverQuest accounts from players who are retiring from the game, typically over a website called playerauctions.com. He then sells the acquired avatars’ items to players through EverQuest’s in-game bazaar in exchange for “plat”–i.e., “platinum pieces,” the game’s currency. Then he exchanges plat for dollars through Internet Gaming Entertainment, a broker specializing in the secondary market for game currency (see “Yield of Dreams”). He has about 20 EverQuest accounts, he says, and keeps at least seven avatars trading “24/7.” Each can be programmed to sell up to 80 items at prices he sets. So he can market up to 560 items around the clock. The most he’s ever received for a single item, he says, was about 3 million plat, which might fetch between $840 and $1,200, depending on where plat is trading against the dollar when he exchanges it.
Anyone familiar with private equity and LBOs will recognize Paul’s sum-of-the-parts-is-greater-than-the-whole business model.
The rise of these markets – playerauctions.com alone claims to have conducted over 4.3 million auctions amongst its 200,000 registered members (charging 5% commission on sale value and various listing fees, this is already a reasonably sized business) would certainly seem to present an interesting opportunity for ‘real-world’ financial services firms.
An interesting question surrounding property rights however does arise from trade in these in-game goods (from same FORTUNE article):
Legally there was an even more ominous prospect. If the company countenanced RMT (real money trade), it might be acknowledging that players gained ownership rights over things they earned or created using the company’s intellectual property. That could have dire consequences down the road. If, for instance, the company altered, upgraded, or discontinued the game–wiping out the virtual wealth it had encouraged its players to accumulate–might it become liable to those players?
Most companies banned RMT in their click-through licenses and demanded that eBay take down auctions for such items; eBay complied, but private auction sites like IGE sprang up to fill the void. Boyd and James Rosini, an IP partner at Kenyon & Kenyon, say that those companies are operating in a gray area. They might be facilitating infringement of the publisher’s intellectual property rights, for instance, or inducing breach of its licensing agreements. “There are myriad colorable claims that could be brought” by a game company that might want to challenge the practice, says Boyd, who sounds as if he’s waiting by the phone. (IGE’s president, Steve Salyer, disagrees. “I’ve sat with the best legal minds in the U.S. over this issue,” he said at a conference recently, “and I’m certain players and IGE are within their rights to conduct the business they conduct.”)
There are signs that game publishers may choose to absorb this new market rather than fight it. In July, Sony set up its own RMT service, Station Exchange. In the first three months of operation–limited to a small fraction of players in just one game–Station Exchange , hosted $540,000 in RMT, with Sony taking a 10% commission on every transaction.
How long is it until USD/EPP (Everquest Platinum Pieces) is as frequently traded as USD/BGN (Bulgarian Lev), afterall the EverQuest economy is ostensibly bigger!
Paul Sloan writes in The Virtual Rockefeller in December’s Business2.0:
To understand the lucrative real estate empire Anshe Chung has created, it helps to spend some time with her “in world.” There, she might teleport you to one of her islands, on the continent she’s named Dreamland. You can stroll through the floating city she built 700 feet above a desert, walk through elegant Arabian-style homes on land she leases, strike up a conversation in Japanese amid her Asian gardens, or shop for a grand piano in one of her 600 boutiques.
It’s all virtual, of course–part of a flourishing online universe called Second Life. And if it sounds absurd, consider this: While Anshe won’t talk about how much money she’s making (“I’m careful not to stir animosity,” she says), Philip Rosedale, the founder and CEO of Linden Lab, which runs Second Life, estimates that she’s bringing in around $150,000 a year–in real, hard cash.
When she joined Second Life just over a year ago, she did so out of curiosity about virtual worlds–to explore how people behaved there and how the experience was different from, say, playing a videogame. “What I found were real people with real emotions and real friendships,” says Anshe, 33. “I also found the economy was very real.”
The initial reaction to stories such as these tends to be along the lines: “I can’t believe people pay real money on virtual goods. (followed by a resigned shake of the head…those crazy kids…)”
Then they pick up the phone or go online and buy a bond. Only when is the last time you’ve seen a bond? What if I told you it didn’t exist? Not in the physical sense. Only in the 0′s and 1′s in the computer systems of your bank or broker and custodian…a virtual good if there ever was one. Ah but you say – that bond can be converted to hard physical cash (let’s not get into the philisophical ‘reality’ of fiat money here!) any time, unlike the virtual real estate (or swords or gold or whatever) that Anshe has purchased…ummm but doesn’t she do just that?
Time to change the frame. I think.
Last year, Thomas Schelling won the Nobel prize for his work on game theory.
Geoffrey Colvin writes a short editorial in FORTUNE exposing just how pervasive Schelling’s work has become in our lives over the last 50 years.
I think this is set to continue and increase. Success in the digital age will be helped by a sound understanding of game theory.