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Twitter’s Market Valuation Suggests Wall St. Sees Huge Growth Potential

Twitter is a young company generating large losses as it competes in a highly uncertain sector of the economy.

And that is exactly why investors clamored for a piece of its initial public offering, which closed on Wednesday evening.

Twitter’s shares were priced at $26, giving the company an overall value of $18.1 billion, including stock that the company is likely to issue to employees. That makes Twitter worth more than many storied American corporations, like Alcoa and Harley-Davidson. At that valuation, each of Twitter’s 230 million users around the world is worth $78. Going by such numbers, the public offering has been a tremendous success for the company, which raised $1.8 billion from the offering, a hefty war chest.

All this is impressive for a company that has racked up more than $300 million of losses in the last three years â€" and may not show real profits until 2015.

But investors are betting that Twitter is virtually destined to become wildly profitable as advertisers pay it increasing amounts of money to reach consumers who use the service.

“The possibilities and opportunities afforded by the platform are limitless,” Dick Costolo, Twitter’s chief executive, said in a company presentation to promote the offering. Still, if recent history has anything to teach, the euphoria is unlikely to last.

The fast-changing world of technology can be cruelly unpredictable. It tripped up companies like Groupon and, for a while, Facebook, Twitter’s much larger rival for advertising dollars. If Twitter also slips up, its shares could tumble fast, too.

“That’s always the peril of high-growth stocks,” said Lawrence Levine, a partner and a specialist in financial valuation at McGladrey, an accounting firm. “So much of the valuation is embedded in the expected growth rate.”

Wall Street’s bullish case for Twitter is seductively simple.

The company has established itself as a major hub for social media activity, alongside Facebook and Google. Now, as advertisers devote more of their spending to Internet campaigns, analysts expect that Twitter will almost inevitably rake in a sizable share of that spending. Its revenue should â€" in theory â€" soar. The company, according to analysts, could post revenue of $1.9 billion in 2015, three times what the company is expected to make this year.

Yet Twitter’s stock price, even before its first day of trading, may already reflect most of that growth.

Shares of Twitter begin trading on the New York Stock Exchange on Thursday. If underwriters exercise an option to sell 10.5 million more shares to satisfy demand in the market â€" in what the industry refers to as an overallotment or “green shoe” â€" the company’s haul will rise to $2.1 billion, and its valuation will grow to about $18.3 billion. Twitter’s underwriters are expected to make use of the green shoe because of strong appetite from investors, according to people briefed on the matter.

The company could start trading with a market value of around 11 times its expected 2015 revenue, according to estimates from Sterne Agee. At that multiple, Twitter would already be more expensive than other social companies, like Facebook, Yelp and LinkedIn. The market is valuing those companies at a lower multiple of 8.5 times their expected 2015 revenue, according to Sterne Agee.

Twitter is not expected to be profitable under generally accepted accounting rules until 2015. Skeptics wonder whether this is because the company is struggling to find ways to serve advertisers.

To a certain extent, social media companies are black boxes, making them harder to value than companies with more visible, conventional businesses. A company like Twitter sits on an enormous number of user interactions, and it has to determine how to exploit those for advertisers. But it has offered few specifics on exactly how it will enable advertisers to place the right ad with the right users.

Twitter has released intriguing numbers that have excited investors. For instance, it says that, in the third quarter of this year, it took in $2.58 in advertising revenue for every 1,000 times that American users interacted with their Twitter accounts. In effect, the company is booking a quarter of a cent every time American users do something on their feeds, which suggests Twitter is sitting on a reliably lucrative business.

Outside the United States, where the company has 77 percent of its users, the figure is only 36 cents for every 1,000 interactions. Bullish analysts say the low figure shows that Twitter has room for growth.

But it is not clear how engaged the international users are compared with American ones. One way to track engagement is to look at how many daily active users Twitter has in each region. But unlike Facebook, Twitter has given only a daily active user figure for the entire company â€" around 100 million, which is less than half the monthly active users.

As Twitter’s public offering was closing on Wednesday, Mary Jo White, the chairwoman of the Securities and Exchange Commission, gave a speech that raised questions about the sort of numbers that appear in Twitter’s financial documents.

“Consider a company that correctly claims it has a hundred million users, and that the rate of user growth is expected to continue to grow at double-digit rates,” she said, while not mentioning Twitter. “What if the bulk of the growth in the number of users is in an area where the company has not yet figured out how to turn those users into paying customers?”

After months of foundering, Facebook found ways to substantially increase its advertising revenue, so far proving its doubters wrong. The temptation is to expect Twitter to do the same. But the problem is that the company may already be priced for perfection.

“One day Twitter will make money,” said Anup Srivastava, an assistant professor of accounting at Northwestern University’s Kellogg School of Management. “But it’s not clear why anyone should pay this much for it today.”



Wall St. Bonuses Over All Are Predicted to Rise 5 to 10% (Bond Traders Excluded)

When it comes to compensation, it looks as if 2013 is going to be remembered as a pretty good year to have worked on Wall Street, unless you are a fixed-income trader.

Financial advisers, asset managers and underwriting investment bankers can expect their 2013 bonuses to rise as much as 15 percent, according to a closely watched compensation survey to be released on Thursday. Over all, Wall Street employees can expect year-end bonuses to grow 5 to 10 percent on average, the second consecutive year of increases, according to the survey, produced by Johnson Associates.

Bonuses for bond traders, who had a terrible year because of interest rate instability, could drop by just as much or more.

The predictions reflect a new reality for Wall Street’s biggest banks, whose fixed-income revenues have plummeted amid a choppy bond market. Banks including Morgan Stanley have expanded their wealth-management divisions, which generate fees from the assets they handle, to balance the instability from fixed income.

“What’s interesting is, for decades almost every year the big Wall Street firms were the highest-paid firms in financial services,” said Alan Johnson, managing director of Johnson Associates. Now, however, the big asset managers are “on par” with what those big firms are making, he said.

Johnson Associates, based in New York, surveyed eight of the country’s largest investment and commercial banks, 10 of the largest asset-management firms and public data.

Bond traders received the largest increase in bonuses last year, but they declined in 2011, reflecting the sector’s volatility.

Some investment bankers will fare far better this year than they did last year, when bonuses fell by an average of 10 percent. While underwriting investment bankers will generally receive larger bonuses, investment bankers on the advisory side should expect drops of 5 percent to 10 percent.

Hedge fund and equities executives can expect bonus increases of 5 to 15 percent, according to the survey. Employees in firms’ private equity businesses can expect 5 to 10 percent increases.

About half of all the money Wall Street makes goes to paying employees, and year-end bonuses make up a large chunk of that amount. But firms set aside money all year for those payouts, and they have not been able to save quite as much this year. During the first nine months, big banks set aside $91.44 billion for 2013 bonuses, down from $92.49 billion in the period a year earlier, according to the survey.

Goldman Sachs employees should not be surprised that during the first three quarters, their firm set aside 5 percent less in year-end compensation than it did last year. Fixed income dragged Goldman’s profit down in the third quarter, a drop that was expected to pull employees’ year-end bonuses down with it. The company also had less revenue from lending and investing activities over all.

JPMorgan Chase’s compensation numbers are roughly flat so far this year. The bank has set aside $23 billion to pay for penalties related to various government investigations and other litigation costs. It is unclear how this reserve will affect bonuses.

“Firms have gotten better at managing people’s expectations,” Mr. Johnson said. “They talk about the results.” He added, “People are more attentive to this than they were years ago.”

Employees are usually told in January how much their year-end bonus will be. These merit-based bonuses, which include cash and stock awards, typically come on top of a base salary, which on Wall Street can vary from $100,000 to more than $1 million for top executives.

Johnson Associates expects bonuses for top bank executives, like Lloyd C. Blankfein, Goldman’s chairman and chief executive, to be flat compared with those last year. Mr. Blankfein’s total compensation was $21 million in 2012, up from $12 million in 2011.

Mr. Johnson said that Wall Street “dropped deeper” during the financial crisis but had recovered faster than Main Street.

“The economy, of course, hasn’t helped either side,” he said.

The big firms have done much to get their costs under control, Mr. Johnson said, but he expects a little more belt-tightening next year and predicted that the wealth management and fixed-income businesses would see improvement.

“I think 2014 will certainly be better,” he said. “Hopefully we’re half to two-thirds through the recovery of Wall Street, but we’re nowhere near done.”



Twitter Prices I.P.O. at $26 a Share

Twitter Prices I.P.O. at $26 a Share

Regis Duvignau/Reuters

Twitter said that it had 232 million monthly users in the third quarter.

San Francisco â€" Twitter, long protected in its Silicon Valley nest, is about to venture into the more unforgiving world of Wall Street.

Document Graphic

On Wednesday, Twitter set the price of its initial public offering at $26 a share, valuing the company at roughly $18 billion. Twitter shares are set to begin trading Thursday on the New York Stock Exchange.

With 70 million shares sold in the offering, Twitter raised $1.8 billion. The I.P.O.'s price, the subject of debate between the board and its underwriters up until late on Wednesday afternon, was above an already heightened price range, reflecting the strong demand for the company’s stock.

Twitter’s initial public offering is a sign of maturity for the social network known for its 140-character “tweets” and its dainty blue bird logo. Seven and a half years after its founding, the service has become an influential public forum, used by world leaders, dissidents, celebrities, megacorporations, small businesses and tens of millions of regular people who want to listen or join in the conversation.

But as Twitter makes the transition to a publicly traded company, investors have reason to be cautious: the micromessaging platform is having trouble attracting and retaining users.

For one thing, Twitter’s interface can be daunting to newcomers. A user has to invest a lot of time to figure out the right accounts to follow and to understand the unique jargon of the service.

And its fundamental design â€" every tweet is delivered in chronological order, no matter how important or trivial â€" means that compelling information can get lost in a sea of babble.

“You see the stream of posts coming at you, and it’s really overwhelming,” said Debra Aho Williamson, a principal analyst who studies Twitter and other social media for eMarketer, a research firm. “It’s all jumbled.”

Rethinking the design of the service has been a lower priority for Twitter’s leadership team, which has focused more on the technical challenges of running the service and on creating sources of revenue, according to current and former Twitter employees. At the same time, the company has no obvious product visionary like the late Apple chief executive, Steve Jobs, to reimagine what the service could or should be to attract new users.

Richard Greenfield, an analyst with BTIG Research, said Twitter drew people during breaking news events, like Monday night’s shooting at a New Jersey mall, but needed to do a better job helping people find topics they were interested in so they returned frequently.

“The challenge is to prevent that person from waiting for the next event to come back,” said Mr. Greenfield. “How do you move that dormant user to every day, or multiple times a day, or every minute?”

Twitter’s slowing user growth, as well as its rising losses, has made for unfavorable comparisons with Facebook, the world’s largest social network, where about 1.2 billion people used the service at least once a month in the third quarter.

Twitter had 232 million monthly users during the same period. That was up just 14 million, or 6.4 percent, from the previous quarter â€" a much slower growth rate than Facebook had when it was the same size.

Twitter declined to make any executives available for this article, citing regulatory restrictions on public statements around the I.P.O.

Unlike Facebook, which is constantly tweaking its interface to make it easy to share and “like” things, Twitter is proudly, almost defiantly, geeky.

Users see an unfiltered flow of text messages, most recent first, filled with @ and # symbols and abbreviations like RT, MT and HT. Everything is treated the same -- a tornado alert from the Weather Channel, a joke from Jerry Seinfeld and a recipe shared by a friend down the street.

And the conventions of the service make reading tweets like deciphering code.

Take this recent Friday-night message from the San Francisco dining blog Eater SF: “EaterWire: last Fort Mason @otgsf tonight, @KronnerBurger at @TheMillSF tomorrow, @SpruceSF starts brunch Sunday: http://eater.cc/17jwNXR.”

Michael J. de la Merced contributed reporting from New York.

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Twitter Prices I.P.O. at $26 a Share

Twitter Prices I.P.O. at $26 a Share

Regis Duvignau/Reuters

Twitter said that it had 232 million monthly users in the third quarter.

San Francisco â€" Twitter, long protected in its Silicon Valley nest, is about to venture into the more unforgiving world of Wall Street.

Document Graphic

On Wednesday, Twitter set the price of its initial public offering at $26 a share, valuing the company at roughly $18 billion. Twitter shares are set to begin trading Thursday on the New York Stock Exchange.

With 70 million shares sold in the offering, Twitter raised $1.8 billion. The I.P.O.'s price, the subject of debate between the board and its underwriters up until late on Wednesday afternon, was above an already heightened price range, reflecting the strong demand for the company’s stock.

Twitter’s initial public offering is a sign of maturity for the social network known for its 140-character “tweets” and its dainty blue bird logo. Seven and a half years after its founding, the service has become an influential public forum, used by world leaders, dissidents, celebrities, megacorporations, small businesses and tens of millions of regular people who want to listen or join in the conversation.

But as Twitter makes the transition to a publicly traded company, investors have reason to be cautious: the micromessaging platform is having trouble attracting and retaining users.

For one thing, Twitter’s interface can be daunting to newcomers. A user has to invest a lot of time to figure out the right accounts to follow and to understand the unique jargon of the service.

And its fundamental design â€" every tweet is delivered in chronological order, no matter how important or trivial â€" means that compelling information can get lost in a sea of babble.

“You see the stream of posts coming at you, and it’s really overwhelming,” said Debra Aho Williamson, a principal analyst who studies Twitter and other social media for eMarketer, a research firm. “It’s all jumbled.”

Rethinking the design of the service has been a lower priority for Twitter’s leadership team, which has focused more on the technical challenges of running the service and on creating sources of revenue, according to current and former Twitter employees. At the same time, the company has no obvious product visionary like the late Apple chief executive, Steve Jobs, to reimagine what the service could or should be to attract new users.

Richard Greenfield, an analyst with BTIG Research, said Twitter drew people during breaking news events, like Monday night’s shooting at a New Jersey mall, but needed to do a better job helping people find topics they were interested in so they returned frequently.

“The challenge is to prevent that person from waiting for the next event to come back,” said Mr. Greenfield. “How do you move that dormant user to every day, or multiple times a day, or every minute?”

Twitter’s slowing user growth, as well as its rising losses, has made for unfavorable comparisons with Facebook, the world’s largest social network, where about 1.2 billion people used the service at least once a month in the third quarter.

Twitter had 232 million monthly users during the same period. That was up just 14 million, or 6.4 percent, from the previous quarter â€" a much slower growth rate than Facebook had when it was the same size.

Twitter declined to make any executives available for this article, citing regulatory restrictions on public statements around the I.P.O.

Unlike Facebook, which is constantly tweaking its interface to make it easy to share and “like” things, Twitter is proudly, almost defiantly, geeky.

Users see an unfiltered flow of text messages, most recent first, filled with @ and # symbols and abbreviations like RT, MT and HT. Everything is treated the same -- a tornado alert from the Weather Channel, a joke from Jerry Seinfeld and a recipe shared by a friend down the street.

And the conventions of the service make reading tweets like deciphering code.

Take this recent Friday-night message from the San Francisco dining blog Eater SF: “EaterWire: last Fort Mason @otgsf tonight, @KronnerBurger at @TheMillSF tomorrow, @SpruceSF starts brunch Sunday: http://eater.cc/17jwNXR.”

Michael J. de la Merced contributed reporting from New York.

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Police Commissioner Said to Be in Talks With JPMorgan

Ray Kelly in talks for JPMorgan job | New York Post

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A Wall Street Island for Lhota

Joseph J. Lhota will not be moving into Gracie Mansion. New Yorkers made sure of that in the mayoral election on Tuesday.

But Mr. Lhota, a former chairman of the Metropolitan Transportation Authority who was the Republican candidate for mayor, would be most welcome if he ever decided to move to another tony address: 15 Central Park West.

Though Bill de Blasio, the mayor-elect, swept the votes in Manhattan, some sections of the borough were staunchly for Mr. Lhota. These included large sections of the Upper East Side and some parts of Midtown, according to a New York Times map of results by precinct.

Another section that went heavily for Mr. Lhota was Election District 75-101, according to the map. Contributing just 39 votes, the district is a tiny triangle at the southwestern corner of Central Park, bounded by 62nd Street to the north, Broadway to the west and Columbus Circle to the south.

Some of the district’s most prominent residents live in 15 Central Park West, a limestone palace designed by the celebrity architect Robert A.M. Stern where a penthouse was sold last year for $88 million. The building is home to a number of Wall Street financiers.

How much love did they show for Mr. Lhota? The Republican won the district by a landslide, capturing 33 votes, or 84.6 percent of the total. Mr. de Blasio emerged with only 5 votes, a mere 12.8 percent. And one vote was cast for another, unnamed candidate.

It is not known how the individuals in the building voted. But public records show the names of the financiers who live there. Below is a partial list:

Lloyd C. Blankfein, the chairman and chief executive of Goldman Sachs.

Daniel S. Loeb, the founder of the hedge fund Third Point.

Rodney O. Martin Jr., the chairman and chief executive of ING U.S., the United States subsidiary of the Dutch financial services firm.

Daniel S. Och, the founder of the hedge fund Och-Ziff Capital Management.

Bruce J. Richards, the chief executive of Marathon Asset Management.

Rajat Sethi, a former Goldman managing director.

Another luxurious building, the Time Warner Center, is also in the area. David Martinez, a Mexican financier, has an apartment there, Azam Ahmed reported last year in DealBook, describing it as “a sleek aerie of steel and stone, high windows and soaring views.”



Vote of Confidence in Mexico’s Version of Amazon.com

The Mexican venture capital firm Latin Idea Ventures said this week that it had made its first investment in an e-commerce company, Linio, a Mexico City start-up that, like Amazon.com in the United States, sells a wide array of products.

The investment, announced on Tuesday, was a sign that Latin Idea, founded in 2000, is growing and poised to make significantly larger investments as Mexico’s nascent start-up scene gains momentum.

The announcement also gives some credibility to Linio’s creator, the European firm Rocket Internet, which has been much criticized for creating copycat Internet companies, mostly of successful American ventures, around the world.

Latin Idea Ventures said it was the largest investor in a $50 million round of financing in Linio, which is looking to capitalize on Amazon’s struggles to gain traction in Latin America. The one-year-old start-up expects to use the capital to expand its current operations not just in Mexico, but also Peru, Colombia and Venezuela.

Other investors in the new round, which closed last week, were JP Morgan Asset Management, Summit Partners, Investment AB Kinnevik, the Tengelmann Group and Rocket Internet of Berlin. All had also invested in prior rounds.

Latin Idea, a late-stage venture capital and growth equity firm, provided about half of the new money, according to the firm’s managing partner, Alexander Rossi. Linio has raised about $100 million to date, he said.

Part of Rocket’s strategy is to create clone e-commerce companies throughout the world, armed with large amounts of capital so they can outspend local competitors.

Because of that, Rocket has often been criticized by Latin American venture capital firms, in particular Brazil. Latin Idea is thought to be the first respected venture capital or private equity firm in the region with which Rocket has partnered.

Latin Idea has been at the forefront of developing a venture capital and entrepreneurial ecosystem in Mexico, according to Susana Garcia-Robles, principal investment officer at the Inter-American Development Bank’s Multilateral Investment Fund, which has long worked to spur development in Latin America.

The firm’s 2006 fund, Mexico Venture Capital Fund II, “was a pioneer venture capital fund” in the country, said Ms. Garcia-Robles, who provided its anchor investment.

Its current much larger fund, the $130 million Latin Idea Mexican Venture Capital Fund III, which started late last year, shows progress. Limited partners in it include the American investors PineBridge Investments and the W.K. Kellogg Foundation, Mr. Rossi said.

The size of that fund, significant for Mexico, has enabled the firm to shift its strategy, Mr Rossi said. “Before, we would put our capital in to grow the businesses but then we would have to look for other partners to help. Now we’re able to do it more assertively on our own,” he said, including leading financing rounds with international investors.

It also counts as investors Mexican pension funds and Nafinsa, a Mexican government-owned development bank.

Still, Mexico’s economy has cooled this year, and total venture capital and private equity dollars invested in the country fell in the first half of this year compared with the same period last year, according to the Latin American Private Equity and Venture Capital Association.

Yet both number of deals and amount of fund-raising dollars have increased, a trend also seen in Brazil, Latin America’s largest economy, reflecting that both countries have growing entrepreneurship movements likely to outlast current economic woes.



SAC’s $1.2 Billion Settlement Clears a Judicial Hurdle

One down, one to go.

Federal prosecutors and SAC Capital Advisors cleared a legal hurdle on Wednesday after Judge Richard J. Sullivan said he would sign off on part of the hedge fund’s historic insider trading guilty plea and roughly $1.2 billion penalty.

“I’m satisfied to the extent my review is required and I’m not sure that it is,” said Judge Sullivan. “There is sufficient basis to approve the settlement.

Judge Sullivan said the case would now turn to the “main event,” a hearing on Thursday before Judge Laura Taylor Swain on the $900 million criminal fine. In an unusual feature of the settlement, if she rejects the deal, SAC can withdraw its guilty plea. Legal experts say it is highly likely that Judge Taylor Swain will approve the agreement.

On Monday, federal prosecutors announced that SAC, owned by the billionaire stock picker Steven A. Cohen, agreed to plead guilty to criminal insider trading charges, pay a record financial penalty and terminate its business of managing money for clients. Other features of the deal including a five-year probation and the installation of an outside compliance monitor.

The guilty plea came after the government brought an indictment in July, a rare criminal action against a Wall Street firm, calling SAC “a magnet for market cheaters.” The indictment cited the guilty pleas of six former employees, and insider trading charges against two others.

Mr. Cohen has not been charged criminally but federal authorities continue to view him and other SAC employees as targets of the continuing insider trading investigation. He also faces a civil action filed by the Securities and Exchange Commission alleging he turned a blind eye at insider trading at his hedge fund.

This week, SAC told its staff that it would convert to a family office, managing only the fortune of Mr. Cohen, estimated at about $9 billion, and his employees. Wall Street banks have continued to trade with the fund despite its admission that it was a corrupt organization.

During Wednesday’s 15-minute hearing, Judge Sullivan said he would ratify a $900 million judgment against SAC in the government’s civil money laundering lawsuit against the hedge fund. That judgment is effectively reduced to $284 million because SAC gets an offset for the $616 million penalty it already agreed to pay federal securities regulators in a related case.

Wednesday’s hearing was attended by at least nine federal prosecutors from the United States attorney’s office in Manhattan, including Richard Zabel, the deputy United States attorney, and Lorin Reisner, the head of the criminal division.

For SAC, five lawyers from the law firms Willkie Farr & Gallagher and Paul, Weiss, Rifkind, Wharton & Garrison showed up, including Martin Klotz from Willkie and Theodore V. Wells Jr. from Paul Weiss.

Sharon Cohen Levin, the chief of the office’s asset forfeiture unit, did all of the talking for the government. Judge Sullivan asked Ms. Levin the deal was contingent upon his approval, as such a civil matter can typically be settled without a judge’s signing off. She explained that the federal marshals will not accept the money for the government’s civil forfeiture fund without a court order.

To which Judge Sullivan said: “Even if it’s that big a check?”

Away from the trading floor, Mr. Cohen is busy this month selling numerous pieces of artwork from his celebrated collection at the Christie’s and Sotheby’s auctions. On Tuesday night at Christie’s, the first of his works was up for sale â€" “Mann und Frau (Umarmung),” a gouache by Egon Schiele from 1917 depicting a naked couple in a hot embrace.

The piece, expected to sell for $5 million to $7 million, went unsold without a bid.

Carol Vogel contributed reporting.



Why Twitter May Have to Pay Income Taxes One Day

Potential investors in Twitters’s planned initial public offering may be struggling to estimate how much the company will have to pay in taxes in the future. An article in Politico on Friday highlighted some of the techniques Twitter might use to legally avoid taxes.

Twitter’s biggest potential tax shelter is its history of losing money. Like most growth companies, Twitter has accumulated a lot of operating losses. These losses, in theory, can be carried forward as net operating losses to offset future taxable income. But investors should not count on it.

Buried deep in Twitter’s S-1 (on page F-43) is a description of the company’s tax assets. A tax asset is an accounting item that represents a possible reduction of a company’s tax liability in the future.

For the year ending 2012, these tax assets total $91 million, a potentially significant amount of tax savings if Twitter starts turning a profit. But the financial statements then explain that management established a “valuation allowance”â€"that is, wrote down the value of the tax assetsâ€"by $42 million. That means the company believes that much of the value of these assets will not be fully realized.

This kind of valuation allowance is not unusual among newly public companies. According to research by Eric Allen of the University of Southern California, 82 percent of companies that held I.P.O.’s record an allowance that reduces the value of the associated deferred tax asset to zero.

Why did Twitter’s managers and auditors decide to write down the value of these net operating losses? There are two possibilities, only one of which should bother investors.

One possibility is uncertainty about Twitter’s ability to ever generate enough income to absorb all of these accumulated losses. If you never turn a profit and never have taxable income, then tax losses aren’t valuable at all. Obviously, such a signal that management doesn’t expect the company to have income in the future should be of real concern to investors.

The more likely explanation, however, is rooted in the details of the Internal Revenue Code. Section 382 restricts a company’s ability to use tax losses in the event of certain ownership changes.

These restrictions were intended to prevent trafficking in tax losses: Congress wants mergers and acquisitions to occur for business reasons, not merely because a target has tax losses that a buyer might use to offset other taxable income. If an ownership change takes place, then strict limitations apply to the company’s ability to use previous tax losses to shelter income going forward.

Section 382 is drafted in such a way that it focuses on changes in ownership among shareholders who own at least 5 percent of the company, and it accidentally catches some ownership changes that it probably shouldn’t.

In the case of Twitter, one may expect many of the founders, venture capitalists and later-stage investors to sell their interests over the months and years to come. These ownership changes are likely to restrict Twitter’s ability to use net operating losses under the Internal Revenue Service Code.

This is an unfortunate result for Twitter, as it destroys a valuable tax asset. For investors, however, this technical legal explanation is at least better than the alternative of never seeing Twitter make a profit in the future.

Victor Fleischer is a professor of law at the University of San Diego, where he teaches classes on corporate tax, tax policy, and venture capital and serves as the director of research for the Graduate Tax Program. His research focuses on how tax affects the structuring of venture capital, private equity, and corporate transactions. Twitter: @vicfleischer



Simple Fix to Debate Over Government’s Role in Housing

Obamacare’s early problems could recast the debate about mortgage market reform.

What does health care have to do with housing prices? A lot, actually.

The stumbles with the Healthcare.gov website and the individual policy cancellations may or may not get resolved soon. But they have served a purpose. They have highlighted the extent to which health care reform is a “kludge,” as Paul Krugman recently wrote, a jury-rigged and complicated structure that extends social insurance largely through private sector means, leavened by a passel of government regulations and subsidies.

Obamacare was a concession to the status quo. Many progressives would have preferred a government-run, single-payer plan â€" Medicare for all â€" but that was politically impossible. Such a change would have been hugely disruptive, since tens of millions of people would have had to be moved off their policies, and many thousands in the insurance industry would have lost their jobs.

So let’s turn to mortgage market reform. Congress is debating what to do about Fannie Mae and Freddie Mac, the government-owned mortgage insurance companies that collapsed during the 2008 financial crisis.

Worried that the government backs too many new mortgages, the Washington consensus has coalesced around a solution that looks a lot like Obamacare. The leading proposals involve getting rid of the Frannies to have private companies create mortgage-backed securities. The government’s role would be to insure some of those mortgage-backed securities, to subsidize the home purchases of the disadvantaged and to regulate mortgage-market players to prevent predatory practices and risk-taking that could lead to taxpayer bailouts. Senators Bob Corker, Republican of Tennessee, and Mark Warner, Democrat of Virginia, have a bill that embodies this harmony.

So what about alternative ideas? There are surprisingly few.

Some conservatives argue for the government to get out of the mortgage market completely. But what passes for the left’s position in Washington is not the opposite of the right’s. The liberal establishment concedes the argument that reform should bring investors back into the housing market and shrink government’s role. They spend their energies pushing to expand and protect housing affordability and access.

The Center for American Progress, a group that has a pipeline to the Democratic mainstream, has played a big role in formulating the current kludge concordance. Even the Center for Responsible Lending, a progressive group dedicated to fighting predatory loans, agrees “with the emerging consensus,” according to a vice president of the group in Senate testimony last month, “that taxpayer risk must be insulated by more private capital.” (The Sandler Foundation, the founding donor of ProPublica, has long been a leading supporter of both organizations.)

What’s almost entirely missing is any unashamedly liberal argument that the government should continue to play a large role in the mortgage market. In fact, it’s taken as a given that too much government involvement is a worrisome thing.

The opposite may well be true: There’s a good argument that preserving the government’s large and active role will make the market safer and more efficient than the reforms.

The consensus has it right that housing is a public good. Homeownership builds wealth, even for low-income households, according to Carolina K. Reid, a professor of city and regional planning at University of California, Berkeley. Of course it’s no guarantee. When the poor buy homes, they don’t stay in them as long as those in the middle and upper classes, meaning that homeownership is more likely to be a losing proposition for the poor than for the better off. Even when the poor do manage to build wealth, they tend to have lower returns than the wealthier. But renters build almost no wealth at all, Professor Reid says.

A large government role in housing is also, let’s face it, unavoidable. As even centrist Republicans agree, the government is and always will be on the hook if the housing market crashes. So many Americans own homes that the government will intervene during a crash. By including the government guarantee in the Frannies’ reform plans, overhaul proponents are conceding that government involvement is necessary to lower the costs of mortgage financing. Given that, it’s probably cheaper for the government to do it as directly as possible. That would be simpler than insuring private mortgage-backed securities, cutting out a whole swath of middle men and overhead.

And it’s more honest. Yes, keeping the Frannies in the government would put their liabilities on the federal balance sheet. Lyndon B. Johnson moved Fannie Mae out of the government to play this very game. But because the government obligation is inevitable, it ought to be transparent and explicit rather than obscure. Keeping Fannie and Freddie as government operations is the cleanest way to do this.

Is it realistic? Keeping the government directly involved in the mortgage market has a big advantage over single-payer health care: It is the status quo. Taxpayers now own Fannie and Freddie and the federal government controls them. It might well be more disruptive to raze them and create a private mortgage market.

This is not a wild proposal; we’ve already tried it. From its creation in 1938 to 1968, Fannie Mae was part of the government. It bought loans from banks and held them on its balance sheet. Homeownership expanded by about 20 percentage points and we had no national housing crashes that wiped out homeowners and the country’s banking system.

Frannie and Freddie’s problems developed much later, after they became publicly traded companies. These “neither fish nor fowl” hybrids had both government charters with implicit government guarantees and had shareholders to please. In their drive for shareholder value, the companies took more risk. And then they lobbied to lower their capital requirements to take even more risk. (They were not the cause of the financial crisis, as some continue to argue.)

The danger of the untested reform proposals is that they may create new versions of this distortion â€" and bring about more reckless risk-taking. In addition, the proposals benefit the banks more clearly than they do homeowners.

Keeping the Frannies as part of the government could resolve this issue. Government operations have flaws, but a voracious appetite for risk is generally not one of them. The mortgage market might become safer.

And, possibly, smaller, with less trading of mortgage-backed securities than we had before the financial crisis. But what matters is the homeownership rate and housing market stability, not how many investors can bet on securities.

A final objection is that any government entity is vulnerable to shutdowns, to horse-trading, to political popularity. Right now, Congress is treating the immensely profitable Fannie and Freddie as a piggy bank. It’s a valid criticism, but one could insulate the Frannies by making them a government corporation, like the Federal Deposit Insurance Corporation.

The kludge consensus may happen to be the best solution. But it’s hard to tell because we don’t hear other visions. Housing was central to the financial crisis. If any topic should generate a full spectrum of radical and imaginative ideas, this is it.



U.S. Investors Brush Aside Fears on Chinese Internet Companies

For American investors, love of technology has conquered a fear of China. Shareholders are snapping up shares of Chinese Internet companies going public stateside. It’s a striking contrast with the recent past, when accounting scams and poor governance prompted many to shun Chinese stocks.

The travel booking website Qunar, which doubled in value on its first day of trading on Nov. 1, is the prime example of the new boom. The same week, shares in the local listings group 58.com â€" billed as China’s Craigslist â€" jumped almost 50 percent on their debut. The interest is proving contagious: Autohome, a car shopping website, filed for an initial public offering in New York on Nov. 5. The online sports lottery operator 500.com and the mobile applications group Sungy Mobile are also preparing to go public.

It’s less than three years since a series of frauds and accounting scams cast a shadow over Chinese companies listed in the United States. Valuations tumbled and I.P.O.’s dried up. Even now, just four Chinese companies have listed in the United States this year, according to Thomson Reuters, raising a total of $358 million. Back in 2010, those figures were 10 times as large.

The latest batch of listings still raises some red flags. Due to Chinese government ownership restrictions, mainland Internet businesses can only be listed overseas by setting up “variable interest entities,” which their offshore parents control through contracts rather than direct shareholdings. The accounts of the new listings are prepared by Chinese auditors, which aren’t supervised by American accounting regulators.

Existing ownership offers some reassurance. The Chinese Internet giant Baidu retains a controlling stake in Qunar, while Autohome has been under the control of Telstra, the Australian telecommunications company, since mid-2008. Nevertheless, investors seem more interested in buying growth than pricing risk. Internet stocks listed in the United States are up 25 percent since the end of June, and China’s expanding economy and increasingly active consumers are powering revenue.

As for all Internet stocks, valuations could prove vulnerable to increased competition or technological changes. Well-known Chinese worries just add a further level of uncertainty. But for now, rapid revenue growth is trumping caution.

Peter Thal Larsen is Asia Editor of Reuters Breakingviews. For more independent commentary and analysis, visit breakingviews.com.



Health Care Deal Is Latest to Seek Corporate Tax Shelter Abroad

Corporate inversions keep on coming as American companies seek ways to avoid paying high taxes.

On Tuesday, Endo Health Solutions, a pharmaceuticals company based in Malvern, Pa., said it would pay $1.6 billion for Paladin Labs, a smaller Canadian drug maker.

But instead of settling in either the United States or Canada, the combined company will be based in Ireland, a move likely to save it at least $50 million a year in taxes.

The deal is the latest so-called inversion, and comes amid a flurry of cross-border deals designed to extract profitable American companies from a more onerous U.S. tax regime.

In Endo’s case, moving to Ireland will lower the company’s effective tax rate to 20 percent, from its current rate of 28 percent, leading to at least $50 million in annual tax savings. With time, those savings could grow, according to analysts.

“We believe there will be additional tax opportunity over time,” Chris Schott, an analyst with JPMorgan Chase, wrote in a research note. “As Endo’s portfolio evolves and the company adds additional assets to its mix, we expect this 20 percent rate to move lower.”

To accomplish the inversion, Endo first had to identify a foreign target that it could buy using more than 20 percent of its own stock. Meeting that 20 percent threshold allows U.S. companies to legally reincorporate in a new country, escaping the American corporate tax rate of 35 percent, which is the highest in the world.

Endo will now set up a new company, called New Endo, in Ireland. The old Endo and Paladin will then each exchange their shares for stock in the new company, thereby allowing it to take advantage of Ireland’s significantly lower corporate tax rate.

On a conference call with analysts, Endo’s chief executive, Rajiv De Silva was remarkably forthright about the motivations behind the move.

“The concept here is a inversion that is enabled by the fact that we are acquiring a company which will end up having more than 20 percent of the shares of the combined Newco, which then allows us to invert into another geography,” he said.

Investors cheered the deal, sending Endo stock up 29 percent on Tuesday, a remarkable bump under any circumstance. That added about $1.4 billion to Endo’s market value, nearly as much as the price it paid for Paladin.

Several big U.S. companies have achieved inversions this year by buying foreign targets. Before Endo, the most recent was Silicon Valley’s Applied Materials, which acquired Tokyo Electron and intends to set up a new parent company in the Netherlands. The move could save Applied $100 million a year.

Pharmaceuticals companies have been among the most eager to invert, especially when they can redomicile in Ireland.

In July, drugmaker Perrigo, based in Allegan, Mich., paid $6.7 billion for Elan, an Irish drug company. Perrigo will now be based in Dublin, and save an estimated $150 million a year.

Actavis, based in Parsippany, N.J., bought Dublin-based Warner Chilcott earlier this year, and will move to Ireland, leading to about $150 million in savings over two years.

Inversions have been political lightning rods for more than a decade, with politicians assailing them as clever ways for U.S. companies to avoid paying their fair share of taxes. And while successive rounds of regulation have made it harder for companies to invert, today inversions can still be accomplished through cross-border deals.

But with about 40 percent of all inversions coming in the last year and a half, according to corporate tax adviser Robert Willens, they are once again under scrutiny by lawmakers.

Last week Sen. Max Baucus, Democrat of Montana, spoke out against inversions in Washington, after The New York Times published an article highlighting the trend.

“Mergers resulting in U.S. companies being owned by companies in tax-haven jurisdictions â€" like Ireland, Bermuda, or the Cayman Islands â€" are a new spin on the old ‘inversion’ problem,” said Mr. Baucus. “And it’s becoming an increasingly popular practice.”

The Senate Finance Committee, of which Mr. Baucus is the chairman, and the House Ways and Means Committee are both working on draft legislation for comprehensive tax reform. Though specifics are scant at this point, their proposals are likely to suggest lowering the 35 percent statutory tax rate, while trying to close loopholes such as inversions.

“When U.S. companies look abroad, they see other countries with more modern, efficient, competitive tax codes. Then they reincorporate overseas by acquiring or merging with another business,” Mr. Baucus said last week.

“They are not necessarily breaking laws,” he continued. “In fact, many of these companies are following the rules of America’s outdated, overly-complicated tax code. But the United States is losing hundreds of millions in revenue as a result. Even worse, when headquarters move abroad, good-paying jobs often move too.”

For now, however, inversions are likely to continue apace.

“The flavor du jour is for companies to acquire Irish companies for this reason,” Liav Abraham, an analyst with Citigroup, said in an interview, speaking about the Endo deal. “It’s a trend that we’re seeing across the industry.”

What’s more, once Endo completes its inversion, it could become a target for a still larger U.S. pharmaceutical company looking to invert, according to one person involved in the deal.

“A $7 billion company that has already inverted can be interesting to a $20 billion company that is looking to do the same,” this person said. “There’s the potential for this stuff to start small and snowball over time.”



Carlyle Reports Lower Earnings for Third Quarter

The Carlyle Group on Wednesday reported lower earnings for its third quarter, amid a slow period in selling its investments.

The private equity giant said it earned $195 million before taxes in the quarter, a decline of 11 percent from the period a year earlier. That pre-tax measure of profit, known as economic net income, accounts for unrealized investment gains and excludes certain costs.

After taxes, Carlyle said it earned $160.2 million in the quarter. That amounted to 51 cents per share, falling short of the estimate of 60 cents a share by analysts surveyed by Thomson Reuters.

The value of Carlyle’s overall portfolio from which it collects profit rose 4 percent in the quarter, the firm said. Its private equity funds were up 5 percent, while its other assets, including real estate, had more modest gains, the firm said.

Carlyle’s results lagged behind two big rivals, Kohlberg, Krarvis, Roberts & Company and the Blackstone Group, which both reported higher earnings in the third quarter. With stock markets rising, many private equity firms have been moving to sell their holdings to the investing public.

But for Carlyle, the third quarter was a relatively slow one when it came to “exits” â€" industry parlance for realizing gains on investments.

The firm said its distributable earnings in the quarter, a measure of payouts to investors in its funds, amounted to $105 million before taxes, a steep drop from $207 million in the period a year earlier.

One bright spot for Carlyle was its fund-raising. The firm raised $6.5 billion in new capital in the third quarter, as it secured commitments from existing investors and attracted new ones.

“We continue to see strong interest from fund investors for Carlyle products, and our overall pace of fundraising is the highest since 2007,” David M. Rubenstein, the firm’s co-chief executive, said in a statement.

Big private equity firms like Carlyle prefer to measure their results using a standard that is not generally accepted accounting principles. But by that metric, Carlyle reported income of $2.3 million in the quarter, compared with $18.6 million a year earlier.



Carlyle Reports Lower Earnings for Third Quarter

The Carlyle Group on Wednesday reported lower earnings for its third quarter, amid a slow period in selling its investments.

The private equity giant said it earned $195 million before taxes in the quarter, a decline of 11 percent from the period a year earlier. That pre-tax measure of profit, known as economic net income, accounts for unrealized investment gains and excludes certain costs.

After taxes, Carlyle said it earned $160.2 million in the quarter. That amounted to 51 cents per share, falling short of the estimate of 60 cents a share by analysts surveyed by Thomson Reuters.

The value of Carlyle’s overall portfolio from which it collects profit rose 4 percent in the quarter, the firm said. Its private equity funds were up 5 percent, while its other assets, including real estate, had more modest gains, the firm said.

Carlyle’s results lagged behind two big rivals, Kohlberg, Krarvis, Roberts & Company and the Blackstone Group, which both reported higher earnings in the third quarter. With stock markets rising, many private equity firms have been moving to sell their holdings to the investing public.

But for Carlyle, the third quarter was a relatively slow one when it came to “exits” â€" industry parlance for realizing gains on investments.

The firm said its distributable earnings in the quarter, a measure of payouts to investors in its funds, amounted to $105 million before taxes, a steep drop from $207 million in the period a year earlier.

One bright spot for Carlyle was its fund-raising. The firm raised $6.5 billion in new capital in the third quarter, as it secured commitments from existing investors and attracted new ones.

“We continue to see strong interest from fund investors for Carlyle products, and our overall pace of fundraising is the highest since 2007,” David M. Rubenstein, the firm’s co-chief executive, said in a statement.

Big private equity firms like Carlyle prefer to measure their results using a standard that is not generally accepted accounting principles. But by that metric, Carlyle reported income of $2.3 million in the quarter, compared with $18.6 million a year earlier.



Battle Over ValueVision Set to Heat Up

The move by activist hedge fund the Clinton Group to try to oust senior executives at ValueVision Media, the Internet and shopping network, is poised to become a bitter battle.

The Clinton Group is expected to send a letter to ValueVision’s board on Wednesday, accusing it of “surreptitiously” seeking to push off a special meeting for shareholders to consider the hedge fund’s proposal to replace five board members. It is also calling for the chief executive to step down.

Earlier this week, the hedge fund announced it had joined forces with Cannell Capital, another hedge fund, to mount a proxy battle for control of the company. Together the two funds have more than 10 percent of outstanding shares in the company. The Clinton Group filed a request demanding a special meeting for shareholders in a document filed to the Securities and Exchange Commission on Monday.

For years ValueVision, which sells jewelry, watches and appliances, has underperformed its competitors the Home Shopping Network and QVC. The Clinton Group contends the business is in need of a makeover.

It is calling for Randy S. Ronning, the chairman of ValueVision, and Keith R. Stewart, the current chief executive, to step down and has proposed a list of candidates for new board members that includes Thomas D. Mottola, the former chairman and chief executive of Sony Music Entertainment, and Thomas D. Beers, the chief executive of “American Idol” producer FremantleMedia.

In a response on Tuesday, Mr. Ronning asked the activist hedge fund to hold off on its campaign to shake up the business until after the end of the holiday season so that executives can remain “laser focused” during the holidays.

“The board is receptive to listening and considering the views of our shareholders, and we are also receptive to the notion of adding qualified independent directors to our board with appropriate expertise in areas that would complement the strengths of our current board member,” Mr. Ronning, the chairman,  wrote in the letter.

But, he added: “We respectfully ask that you withdraw your request for a special meeting until after the end of the holiday season so that our management can devote its full energy to running the company at this important time.”

In a new letter to the board on Wednesday, the Clinton Group will accuse Mr. Ronning of misleading shareholders by asking the hedge fund to withdraw its special request and file a new one in February. This would give the board until May to hold a meeting.

According to Minnesota law - which requires a company to hold a meeting within 90 days of a request for special meeting - ValueVision currently has until the end of January to hold a special meeting for shareholders.



Experian to Buy U.S. Health Care Data Company

By Matt Scuffham

LONDON | Wed Nov 6, 2013 5:03am EST

(Reuters) - British credit data provider Experian said it would suspend a $500 million share buy-back program after agreeing to buy a U.S. healthcare data firm for $850 million, sending its shares lower on Wednesday.

Experian's acquisition of Passport Health Communications follows its $324 million deal to buy U.S. fraud detection firm, 41st Parameter, last month.

The British company first entered the U.S. healthcare payments market five years ago and has steadily expanded its position through investments and acquisitions.

Experian had also spent $322 million on buying back shares from investors at the end of September, having committed in May to buying back half a billion dollars worth in the next 12 months.

The company, best known for running consumer credit checks for banks, landlords and retailers, said it would stop returning money to shareholders via the buyback following its latest acquisition.

"There's a little bit left to go but it doesn't make sense to continue, Chief Executive Don Robert said.

However Robert said the group planned to continue to increase its dividend payouts to shareholders. The group is paying an interim dividend of 11.5 cents per share, up 7 percent.

Experian reported a 2 percent rise in first-half pretax profit to $573 million. Revenue from continuing businesses rose 6 percent.

Robert said he expects organic revenue growth to be in a similar range as in the first half.

Shares in Experian, which have risen by 28 percent since the start of the year, were down 6.6 percent at 0930 GMT (4:30 EDT).

Bank of America Merrill Lynch downgraded the stock to "neutral" from "buy", citing the stock's high valuation and disappointment over its rate of organic growth.

"Investors may also question the shift in capital allocation to more expensive M&A," it said.

E! xperian said it would fund the acquisition of Passport Health Communications with its existing debt facilities.

(Editing by Erica Billingham)



Investors Cool to 2 Chinese Bank Offerings

Two Chinese banks that sold nearly $2 billion worth of shares in Hong Kong stock market listings received lukewarm receptions on Wednesday from investors concerned about how China’s financial system will cope with a potential deluge of bad debt that could swamp the country’s economy.

Huishang Bank Corporation, a regional banking group based in eastern Anhui Province, priced its initial public offering at the bottom end of the marketed range on Wednesday, raising 9.2 billion Hong Kong dollars, or $1.19 billion, according to two people with knowledge of the deal, who declined to be identified because the information was not yet public. Also Wednesday, shares of Bank of Chongqing closed slightly down on their first day of trading after the company raised 4.2 billion dollars in a share sale.

Although both banks had boasted net profits that grew at more than 25 percent annually during the past three years, and had reported bad loan levels that were well below the industry average, they were able to list only after pricing their shares at practically no premium to the value of their assets.

That implies investors are skeptical about the quality of the loans on the banks’ books and their ability to increase future profits â€" an extension of a growing wariness toward Chinese banks and a reflection of broad doubts about the health of the country’s financial system.

“There are growing concerns that the government is becoming less tolerant of egregious lending, and that examples may be made among smaller or poorly capitalized lenders,” said Ben Simpfendorfer, an economist and the managing director of Silk Road Associates, a financial consulting firm in Hong Kong. “Those fears may play out across the sector more generally.”

In the five years since the global financial crisis, China’s economic resilience has been driven by a doubling of bank lending and the rapid rise of so-called shadow banking.

Local governments were responsible for much of that borrowing, as they plowed money into hulking infrastructure or pet projects in an attempt to create jobs and increase gross domestic product.

Now, as growth slows and the new leadership in Beijing searches for ways to rein in wasteful investment and reckless lending â€" topics that analysts say are on the agenda of a key Communist Party planning session that begins Saturday â€" some analysts and investors see big trouble ahead, especially for the financial institutions that bankrolled local government spending sprees.

Because local governments in China are banned from taking loans or issuing bonds directly, and cannot guarantee such debt, they have relied on specially created holding companies called financing vehicles. At the end of June, total bank debt accumulated by these local government financing vehicles amounted to 9.7 trillion renminbi, or $1.6 trillion â€" equal to about 13 percent of all bank loans in China, according to a report published this week by Moody’s Investors Service, a credit rating agency.

Moody’s surveyed nearly 400 local government financing vehicles in June, concluding that only 53 percent of them had enough cash available to meet their debt and interest payment obligations in 2013 without resorting to refinancing â€" or taking on new debt to pay off the old. “The standalone financial profiles of many L.G.F.V.’s are very weak,” the ratings agency concluded.

Ted Osborn, a partner at PricewaterhouseCoopers in Hong Kong who specializes in restructuring bad debt, described the problems at small city commercial banks and regional banks as “the biggest issue that China needs to overcome.”

“The big banks will of course always be supported by the government, but if you take a look at these smaller banks, they have lent probably half of that financing to the local government vehicles,” he said Tuesday at a financial forum in Hong Kong organized by the law firm Latham & Watkins and the Asia Securities Industry & Financial Markets Association.

Mr. Osborn cited a side effect of a wide-ranging anticorruption campaign China is conducting at the behest of President Xi Jinping: The many midtier government officials who have been implicated are often the same people who approved and directed the loans to local government projects that are raising concerns among investors.

“If these loans are bad and more loans go bad than expected, these smaller banks don’t have the capital â€" and don’t have the ability to raise capital â€" that the larger banks have,” he said. “That’s where I see a potential crisis growing somewhere down the road.”

Gaining the ability to raise capital is one factor that has driven China’s smaller banks to seek I.P.O.’s. In its filings for its Hong Kong listing, Huishang Bank disclosed that its lending to local government financing vehicles was equal to 10.7 percent of its total assets as of June. For Bank of Chongqing, the figure was 12.9 percent.

Because local governments cannot offer guarantees for such borrowing, the loans are often backed by the projects they are intended to fund. Doubts have been raised about the quality of that collateral and whether it can generate the returns needed to pay back the debt.

As an example of such a project, Mr. Simpfendorfer, of Silk Road Associates, cited an international marathon course that was built by officials in Changde, in the central province of Hunan. The course, which partly surrounds a lake, was paid for in part by the proceeds from a bond that was issued by a local government financing vehicle.

“It is one of those headline-grabbing projects that makes good press,” Mr. Simpfendorfer said, but he added that it appeared unlikely to generate much of a financial return.

Indeed, even the banks making loans to local government entities have raised doubts over the viability of the projects they are ultimately funding, and whether the debts will be repaid.

“Many projects sponsored by local government financing vehicles are carried out primarily for public interest purposes and are not necessarily commercially viable, and therefore, the operating cash flows generated from such projects may not be sufficient to cover the principal and interest on the relevant loans,” Bank of Chongqing said in a risk disclosure in its I.P.O. filing.

“The ability of a local government financing vehicle to repay its loans may depend to a significant extent on its ability to receive financing support from the government, which support may not always be available due to the government’s liquidity, budgeting priorities and other considerations.”



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