6 Ways To Short Silicon Valley With A Bubble Basket Of Shorts

Written by Dana Sanchez
1 of 7

 

The “bubble basket” is a collective term used by hedge fund manager David Einhorn for tech stocks he believes are overvalued.

Einhorn is founder and president of Greenlight Capital, famous for short selling Lehman stock before Lehman Brothers’ collapse in 2008. The fund invests primarily in publicly traded North American corporate debt offerings and equities. Greenlight was fined $11 million in January 2012 for insider trading in the U.K.

Einhorn announced he had created the bubble basket at a conference in May 2014, Business Insider reported. He added Amazon to his bubble basket of short positions, according to his fund’s Quarter 3, 2014 investor letter.

With tax reform prospects fading, Greenlight recently warned of a bubble, Bloomberg reported on April 25, 2017:

Stock market valuations have become divorced from reality as the likelihood of tax policy changes to drive company earnings has slipped, according to David Einhorn’s Greenlight Capital.

“The bulls explain that traditional valuation metrics no longer apply to certain stocks,” the New York-based firm wrote in a letter to clients Tuesday that was seen by Bloomberg News. “Perhaps as the prospects for tax reform have dimmed, the market has regained enthusiasm for profitless companies that aren’t at risk of paying taxes.”

Short sellers bet that a stock, sector or broader benchmark will fall in price. “Long investors,” by comparison, bet that prices will rise. Here’s how it works, according to Daily Worth:

Say you think a company is overpriced at $50 a share. You borrow 100 shares from your broker—pay interest on the loan—and sell them for $5,000. Time ticks on, and as you suspected, the stock price falls. At $40 a share, you buy 100 shares for $4,000 and return them to your broker. You walk away $1,000 richer, minus investing costs.

That’s a successful short. But what if the stock gains in popularity? Say the price rises to $60 a share, or $6,000 for those 100 shares you need to return. You’re out $1,000.

You’re selling something you don’t own. The goal is to sell high and then buy low.

If you think that Silicon Valley will have a day of reckoning similar to 2000, when valuations are high and the IPO window closes down, here are 6 ideas to start building your Silicon Valley bubble-buster portfolio.

Bigstock
Bigstock

1. Short SharesPost 100

The SharesPost 100 Fund is a non-diversified, continuously offered (interval), closed-end, management investment company in the U.S., according to a Bloomberg profile. The fund’s objective is capital appreciation. The fund invests in the equity securities of certain late-stage, private, operating, venture backed growth companies.

Returns on many late-stage venture-backed companies are historically attractive, according to Sharepost. Typically, these have only been available to institutional and high-net-worth investors:

With many high-growth companies staying private longer than ever, a significant portion of their value appreciation typically occurs before their entry into the public markets.

The SharesPost 100 Fund is available for a minimum investment of $2,500 without investor accreditation requirements. It offers individuals, family offices and institutions access to the venture-backed asset class.

Silicon Valley Bank. Photo: pymnts.com

2. Short Silicon Valley Bank

If there is a big slowdown in tech investment, Silcon Valley Bank would have material exposure.

It’s not well-known or well-understood by the public, but most startups with a little revenue take on a pile of debt alongside or after their equity fundraises, Fortune reported. Silicon Valley Bank is one of the best-known players in that market.

A bank that lends to venture capitalists and startups runs unusual risks, according to Barrons . In the dot-com bust of 2000-2001, Silicon Valley Bank shares fell 60 percent. Despite bulls’ contention that venture-capital and private-equity portfolios are more diverse these days and partially offsetting, 39 percent of Silicon Valley Bank’s $19.3 billion loan portfolio goes to lending venture capitalists and startups or their clients.

SVB (ticker: SIVB) is the parent of Silicon Valley Bank, using its unique location to build long-term relationships with venture-capital and private-equity specialists and tech companies among others. It lends to these borrowers, at times taking equity stakes, and provides money-management services. It’s unusual in holding equity warrants from 1,739 companies, which in its most recent valuation at year-end 2016 were worth $131 million.

Although mainly a corporate lender, the bank’s retail clientele provides a glimpse of how the bank differs from peers. “Something like getting a mortgage when all you have is illiquid founders’ shares, and other banks won’t help, makes a difference you remember,” said Jeff Richards, a managing partner at venture-capital firm GGV Capital, according to Barrons.

Investors are loving SVB shares, which have risen 78 percent in the past year, outpacing the regional bank group’s 40 percent gain. SVB could be poised for several years of rapid earnings growth that dwarfs expectations for most banks. It could allow the bank’s stock to rise another 25 percent or more in the next year, according to Barrons.

“Silicon Valley is strategically positioned to grow even more from events now unfolding, such as rate hikes, lower corporate tax rates, and improvements in the initial-public-offering market,” said David Long, an analyst at Raymond James.

In its latest earnings conference call, Silicon Valley Bank CEO Greg Becker said, “It’s widely expected that corporate tax rates will fall and uncertain regulatory requirements impacting banks may be relaxed.” At 40 percent, SVB has one of banking’s highest tax rates — most of its business is done in California and Massachusetts which have high taxes. “Any changes in corporate tax rates are likely to be a big help to SVB’s bottom line,” Jack Willoughby reported for Barrons.

NEMA apartment building under construction, 2013, San Francisco. Photo: sf.curbed.com

3. Short REITs with Bay Area exposure

With venture investments at a peak, there are a lot of startups seeking office space. But as private capital becomes less abundant, those offices may end up empty, according to Amey Stone in a January 2016 Barrons report. Apartment buildings could also struggle for tenants.

REIT stocks would turn negative long before any vacancies began to appear. Analysts write:

We think any meaningful indication that the private tech market is headed for a sustained downfall will impact tech-heavy REIT stocks in all property sectors, and in a negative way. The theory being that the future would become uncertain, causing investors to take a more cautious stance. Negative sentiment has already had an impact on some office REIT stocks even in the absence of any tangible slowdown in market rent growth. We worry about what happens next – if/when the issues pivot from sentiment to reality.

The report doesn’t mention any REITs by name, but apartment REITs that have San Francisco holdings include AvalonBay Communities (AVB), Equity Residential (EQR), Essex Property Trust (ESS) and UDR (UDR). Office REITs in the area include Kilroy Realty (KRC) and Hudson Pacific Properties (HPP), according to published reports.

Bigstock

 

4. GSV Capital

Let’s say you’ve come to the conclusion we’re in a tech bubble and you’re in the position to put your money where your mouth is. Can you actually short the tech bubble?  “The short (ha) answer is no, because the companies and their investors are privately held. But that hasn’t stopped some investors from coming up with creative methods,” Erin Griffith wrote in Fortune.

One way might be to short publicly traded investment firms and funds with exposure to startups, Griffith said. That includes GSV Capital.

GSV Capital (NASDAQ: GSVC) says at its website that it offers the first publicly traded security enabling any investor to own a piece of the world’s most dynamic, venture capital-backed private companies.

The investment company mostly seeks capital gains on its equity and equity-related investments. It invests mainly in the equity securities, which are venture capital-backed emerging companies, according to a profile in the Cerbat Gem.

GSV Capital Corp saw a significant decrease in short interest in March. As of March 15, there was short interest totaling 597,101 shares, a decrease of 3.3 percent from the Feb. 28 total of 617,351 shares.

Separately, Wunderlich downgraded shares of GSV Capital Corp from a “buy” rating to a “hold” rating in a report on Friday, March 17.

Large investors have recently modified their holdings of the company. You can read more here.

“We’re huge believers in megatrends,” GSV asserts. “The powerful technological, economic and social forces that create growth opportunities. Megatrends provide our top-down view of the world.”

Bigstock

 

5. Facebook

Marketing spend on Facebook could come under fresh pressure if venture capital money contracts significantly. Sizeable marketing spend goes to Facebook from unprofitable tech companies attempting to acquire and keep customers.

Facebook stock is likely already overvalued and set up for a big fall, according to Andrew left, a short-seller with Citron Research who got famous following a bearish analysis of Valeant Pharmaceuticals Inc.

In a July 2016 Bloomberg report, Left talked about the Facebook’s future market value. He didn’t give a price target for his short position, which involves borrowing Facebook shares and selling them to profit if the stock declines:

“So by me saying that maybe in a year and a half from now Facebook is going to be a $200 billion dollar company or a $250 billion dollar company, it’s not such a bad thing,” he said.

Facebook’s market cap was $442.17 billion on May 1, 2017.

Bigstock

6. Snapchat

Snap Inc (NYSE: SNAP) made its IPO debut on March 2, 2017. Once that first public trading session is over, investors watch the next big date that looms over any large IPO — lock-up expiration — said Wayne Duggan, reporting for Lightspeed.com.

Here’s why Duggan said he thinks the lock-up expiration is important:

Most IPOs have a lock-up period ranging from 90 to 180 days after the IPO date. During that time, insiders, majority shareholders, and anybody else who had access to the stock before it traded on a public exchange are restricted from selling their shares of the stock on the public market. The purpose of the lock-up period is to reassure new public investors that they will not be buying into the stock at the same time a flood of company insiders are dumping their shares en masse. Once the stock has a period of time to stabilize on the public market, the lock-up expiration allows insiders to begin cashing out of their holdings, if they want.

The reason why IPO investors should be concerned about lock-up expiration is because stocks, like any other asset in a free market, are priced based on supply and demand. Once insider shares are no longer restricted, a stock’s float (public market supply) dramatically increases. Of course, this expiration only becomes an issue if insiders actually sell their shares, which they often do not. But the risk of insider dumping can be a bit higher at tech companies like Snap, where so many of the insiders are relatively young and may have a hard time resisting the temptation to become instant multi-millionaires.

Much like any other major market catalyst, lock-up expirations can be difficult to trade around. When Alibaba Group’s (NYSE: BABA) largest lock-up expiration took place, the stock tumbled 2.7 percent. But the lock-ups are planned well ahead of time, so stocks also tend to be weak headed into expiration dates. Alibaba, for example, plummeted nearly 30 percent in the year ahead of its lock-up expiration. Once the expiration had passed, the subsequent “relief rally” drove Alibaba shares 65 percent higher in the year that followed.

Facebook Inc (NASDAQ: FB) demonstrated a similar trend. In the six months leading up to Facebook’s largest lock-up expiration, shares plummeted 48 percent. On the day of the expiration, the stock jumped 11 percent.

However, Facebook and Alibaba’s lock-up trading pattern doesn’t always hold true. Twitter Inc (NYSE: TWTR), for example, gained 24 percent in the six months heading into its largest lock-up expiration only to see shares immediately plummet 18 percent on expiration day.

Key Snap lock-up dates

Traders looking to trade the Snap lock-up should pay attention to how the stock trades headed into the expiration and whether or not there is a wide-scale exodus on the day of the expiration. If not, it could serve as an excellent buying opportunity.

The first key lock-up date for Snap will occur roughly 150 days following the IPO. At that point, pre-IPO investors, such as company insiders, will be allowed to sell their shares. The second major lock-up date applies to 25 percent of the shares that were offered in the IPO itself. Of the 200 million total IPO shares, 50 million of the shares will be restricted for one year.

View Comments