ELON MUSK`S $1.25 TRILLION MIRAGE / PROJECT SYNDICATE

Elon Musk’s $1.25 Trillion Mirage

More often than not, share prices are rigged, which is why they are a dreadful predictor of profitability even on average, and why they have become the primary instrument for transferring wealth upwards. The SpaceX-xAI merger tells much of this sorry tale.

Yanis Varoufakis

ATHENS – The recent merger of SpaceX and xAI, a financial spectacle greeted with celebratory yelps from the usual quarters, is a sight for sore eyes. 

More accurately, it is a sight for eyes still sore from what they witnessed 25 or so years ago, when Wall Street’s perfection of the dark art of corporate mergers sent phoney valuations into the stratosphere, before they crashed back to Earth. 

As Elon Musk cashes in, we are left staring at a perennial flaw of modern capitalism: a market forever eager to buy its own illusions.

Like all large-scale swindles, this one comes complete with a pseudo-scientific cloak: the touching faith that a company’s share price is the best indicator of its underlying value – a rational predictor of its future wealth, health, and profitability. 

The fact that the creative calculus behind the $1.25 trillion valuation of SpaceX-xAI went unchallenged can be explained in two words: motivated irrationality.

There is little doubt about motivation, given the millions to be made by the many financiers going along with it. 

As for the valuation’s irrationality, it becomes transparent after a closer look at the similarities with the fraudulent arithmetic which once propelled the AOL-Time Warner and Daimler-Chrysler mergers.

But first the broader point needs to be emphasized: more often than not, share prices are rigged. 

That is why they are a dreadful predictor of profitability even on average, and why they have become the primary instrument for transferring wealth upwards, while disguising systemic rot as the miracle of the market. 

The SpaceX-xAI merger tells much of this sorry tale. 

The practice of share buybacks tells the rest.

Let’s begin with the logic behind Musk’s stupendous merger, an echo of its precursors in the late 1990s and early 2000s. 

To see how the thinly disguised fraud works, consider two widget producers: Goodwidget, an old, boring firm, with a solid track record, and AIwidget, a trendy upstart. Goodwidget, a 30-year-old company with annual earnings (E) of $5 billion and an annual growth rate of 10%, has a $50 billion capitalization (K), implying a prudent 10:1 capitalization-to-earnings (K/E) ratio. 

AIwidget, by contrast, has been around for about a year, during which it earned $2 billion. 

Yet, based on frothy projections of its capacity to tap into an AI-empowered future, its capitalization is $100 billion, yielding a dizzying 50:1 K/E ratio.

A rational person might see Goodwidget as the safer bet. 

But Wall Street sees things differently. 

A reasonable valuation of the merged entity would simply add together the two capitalizations: $50 billion + $100 billion = $150 billion. 

Too timid! 

For Wall Street, the name of the game is multiplication, not simple addition. 

So, instead, they add up the two companies’ earnings ($5 billion + $2 billion = $7 billion) and then multiply the total by the higher K/E ratio – that of the frothy AIwidget. 

The new company’s capitalization soars by a cool $200 billion to $350 billion (50:1 x $7 billion). 

The merged company, visited by the financial tooth fairy, rides the tsunami of hype that catapulted AIwidget’s market value just before the merger.

Why Wall Street’s moneymen engineer this is obvious: their fees and commissions are derived from the final fabulous figure. 

But why do investors turn a blind eye? 

The reason is always the same: what matters is not whether they believe the phoney arithmetic, but that they believe enough investors believe that many investors believe that enough investors will turn a blind eye to specious math.

The fact that these mergers eventually crash and burn (the fate of Time Warner and Chrysler) offers no evidence that the market “gets it right on average.” 

It proves that prices can be wrong for a very long time, until the music stops and a great many people lose a great deal of money – before the rigging begins anew.

And then there are the share buybacks that support rigged prices between booms and busts. 

Legalized in 1982, after being wisely banned by US President Franklin Roosevelt’s New Dealers in 1934, buybacks are dressed in the benign language of “returning value to shareholders.” 

The official story – that they are just like dividends – is an intellectual fraud. 

Yes, both enrich shareholders – and there the similarity ends.

Think of a company as an eight-slice pizza. 

A dividend is an extra sliver of pizza for every slice-holder; you get a tangible benefit, but your ownership stake (your slice) remains the same. 

You also pay tax on the new sliver immediately. 

A buyback, by contrast, is the equivalent of the company buying and destroying two of the eight slices, so that now you own one-sixth of the pie. 

You don’t have to pay taxes until you sell, but you can benefit from the type of fraudulent merger discussed above, based on artificially boosted valuations.

That is the crucial difference. 

A rising dividend signals management’s confidence in future profits from real growth, and it comes with a rational constraint: if the dividend is too high, investors may fear the company is starving its future, and the share price may fall. 

A buyback signals no such thing. 

It is a financial engineering trick to inflate the share price. 

It ransacks the company’s cash pile not to build, but to create a tax-deferred, compounding illusion of value.

The New Dealers outlawed buybacks because they knew a tool for manipulation and looting when they saw one. 

And that is why the kleptocracy that rose on the coattails of Margaret Thatcher and Ronald Reagan pressed to allow the practice.

Between the alchemy of mega-mergers, the price-pumping of buybacks, and the ocean of cheap central-bank money that lubricated it all after the 2008 financial crisis, the notion that share prices reflect true value has become a trick played on everyone with no stake in mirages like Musk’s $1.25 trillion fantasy.

Yanis Varoufakis, a former finance minister of Greece, is leader of the MERA25 party and Professor of Economics at the University of Athens.