A new parlor game: which tech stocks is David Einhorn shorting?
This news might cause some consternation among Valley inhabitants who are waiting for their stock to vest but one of Wall Street's more aggressive investors, David Einhorn, has started shorting certain tech stocks on the basis that we're seeing something of a rerun of the dot-com mania. And if he's right some people are going to be very upset indeed when their stock does vest. Bloomberg writes:
Greenlight Capital Inc., the $10.3 billion hedge-fund firm run by David Einhorn, said it was betting against a group of technology stocks as evidence grows of a bubble.
“There is a clear consensus that we are witnessing our second tech bubble in 15 years,” the New York-based firm said in a quarterly letter to clients today.
Greenlight said that companies it’s betting against may fall by at least 90 percent “if and when the market reapplies traditional valuations,” I don't think it will surprise anyone that outside observers of the scene think that valuations are becoming a little frothy in certain sectors. Facebook has recently been trading at 100-times earnings, which is pretty good for a company that already has as customers nearly all of the planet's billion affluent people. By definition new users are going to be poorer and thus less valuable to the company's advertising machine. There's also the little point that every previous social network abruptly imploded as soon as the cool kids left and took everyone else with them. A couple of billion for a photo sharing app with no revenue whatsoever would also make fans of "traditional valuations" raise an eyebrow or two.
As to what Einhorn is actually doing, he's selling shares that he doesn't currently own (and borrowing them from other investors so he can make delivery) in the hope of being able to buy them back later at a lower price. This is "shorting" and it's viewed by some as being an extremely naughty financial practice, to the point that it's illegal over in Europe in certain stocks. However, as 2013 Nobel Price for economics winner Robert Shiller has pointed out, there's good reason as to why shorting should be allowed.
The idea is based upon Galton's Ox: people pay some small amount at a fair to guess the weight of a dead cow. The person who gets closest to the correct weight then wins a prize (some fraction of dead cow). The individual guesses are spread over a ludicrously wide band, people with absolutely no relevant knowledge at all just tossing out guesses. There are also those more informed, those who have butchered a dead cow before perhaps. What Galton noted was that while the individual guesses were all over the place the average was pretty close to being accurate.
Shiller uses this to point out that we'd like prices in a market to be accurate and this means that we've got to have all opinions on what the price should be expressed for this to be possible. That means, obviously, that people should be able to buy in the expectation that prices will rise: but also that they should be able to bet, speculate, go short, in the expectation that they will fall. Shiller, who was the "not right wing" one of the three Nobel winners las tyear, takes this far enough that he recommends that the way to avoid bubbles is to have more speculation. For some will speculate on falling prices, as Einhorn is by going short, and this will in itself aid in reducing the inflation of the bubble.
So, in Shiller's vision, Einhorn is actually deflating a bubble in the tech sector by going short on tech stocks. If there's no bubble he's simply wrong, but if he's right he's reducing the problems that might be associated with it.
While that's the economic background, it's not even the interesting part. Rather, it's the parlor game around precisely which companies Einhorn is that deserves the most attention. I would put Facebook forward as a candidate, partly on the grounds that its valuation is very high and partly on the grounds that companies that grow explosively through network effects can also shrink alarmingly quickly as a result of the same effects – and partly, well, because I just don't like using it.
Smart people in hedge fund offices around the world are surely offering up the names of companies they think Einhorn is shorting on any similar logical or illogical grounds.
I'd add that King, the recently IPO'd maker of Candy Crush, probably isn't on the list however tempting it looks. You can't short stock immediately after an IPO and I don't think they've been out long enough yet. And I also don't think Apple will be on the list, as they're looking very cheap indeed at the moment based on traditional valuation methods.
Feel free to play along at home, and if you're brazen enough, to put your money where your mouth is by playing the markets.
[Image via MBLblog]