Many investors who enjoy taking bets on companies that will lose value are breaking out the champagne. They are celebrating due to the new supply of shares from these companies are pushing the cost of “shorting” the stocks down.
Short sellers borrow shares of companies from brokers and sell them in the hope of buying them back at a lower price later. For example, I borrow 100 shares of company A from a broker and it is priced at $10/share. If the stock goes down to $8.00 I only owe the investor the 100 shares I borrowed…so I make a $200 profit. However, if the stock price rises to $12.00 then I still owe the 100 shares, and I have to pay the difference out of pocket ($2/share for 100 shares = net loss of $100).
Until recently, the “free float” of recent tech companies that had IPOs was only about 10%. A free float is the number of shares outstanding…for most of the companies; only around 10% of their shares were actually being traded. LinkedIn is a prime example of how investors were reacting. After its IPO, the cost to borrow LinkedIn shares was 183% of the share price…this meant that in order to hold $1 million in shares it would cost the borrower $1,830,000 (according to SunGard’s Astec Analytics).
Recently, LinkedIn utilized a second offering of 8.75 million shares and the cost to borrow fell from 183% down to 6.9% making a lot more viable to be a short seller. As Andrew Shinn, director of research at Astec Analytics in New York said, “With LinkedIn’s cost to borrow more reasonable, that is going to draw a lot more hedge funds into this trade that were unwilling when the cost was higher”.
Expect a lot of these companies to drop in price; especially because many of them are overvalued…Pandora is trading at 255 times its projected earnings, while Google is only trading at 17 times its projected earnings.
LinkedIn is not alone in these shorting transactions…many of the recent IPOs have investors taking bets that they will fall in price. As stated by an investor with a short position, Mr. Edstadt, “All I want for Christmas is for Groupon to keep falling”.