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Beat the Wall Street insiders at their own game
Make money while the rest of the world takes a bath
by Christian DeHaemer
The IPO market has provided the stage for the single greatest transfer of wealth to the legally larcenous liars of Wall Street since the Hoover administration. Over the past few years we have seen untold trillions gambled away on over-hyped fad stocks. Whether it was Netscape, WebMethods or TheGlobe.com, some fool was always placing market orders at the top.
Things eventually reached a height so absurd that from this vantage point it seems unscalable. I don't mean to insinuate that anyone buying WebMethods at US$305 is still in it today at US$95. You just have to know when to get out of a losing proposition.
Not that buying into an investment Macarena is always bad. Those few with perfect timing or the necessary luck can make a killing. But most people go about it the wrong way.
The only reason for buying a company with no upside catalyst is because you believe it is so inexpensive in comparison to its peers that you can buy now and wait for a catalyst to appear. This is the exact opposite of what happens in the aftermath of an IPO. Read on, and discover a secret so simple and profitable that you'll wonder why you aren't already using it on a daily basis. But first, some simple background information.
Go thin, you're in
I've been talking about eflation for a couple of years. It's the process by which supply and demand, short sellers and thin floats combine to send a stock through the ionosphere.
When a company goes public, it issues a large number of shares (say ten million at US$13), but at first only offers 1.5 million for sale. This is called the float, i.e., the number of stocks available for public trading.
Now, if it's a good company with a solid business plan and a future packed with growth potential, you can expect it to garner a great deal of media interest. Company hacks will be on the hallucinogenically happy CNBC telling the world about how they are going to revolutionize the way their business is done.
The "Brain" tosses them softball questions about their home town and favorite flavor of ice cream.
CBSMartketwatch showcases them at the top of the headlines. The small number of shares and big buzz insures that the stock gallops out the gate. The insiders, their family and friends, and the brokerage company that took them public rejoice. On their way home they will all buy themselves red convertible Porsches.
The small amount of stock available will then be taken over by the short sellers, who realize that there is no way a doughnut company (KREM:NASDAQ) with US$12 million in annual income and 3% margins should have a market value of US$1.25 billion. This pushes the number of shorts to extremes and sucks up the available shares. Thirty-five percent of the Krispy Kream shares are now in the hands of short sellers.
This sets the stage for a classic short squeeze. The shares move up, the momentum guys take them higher, more shorts try to borrow the shares that aren't available. And up it goes until something cracks, or the supply of shares increases...
Supply demands a body count
Like any market, the NASDAQ must adhere to the laws of supply and demand. The selloff over the summer can be directly correlated to an enormous increase in supply. And according to Thomson Financial Securities, there are 280 companies that are planning to go public before the end of the year.
These companies presumably believe that there is US$36 billion in loose change waiting to be dumped back into new ventures. The number of companies that want to go public in Q4 this year is the same as went public in all of 1998.
Furthermore, due to the deluge of IPOs last spring, there is a flood of lockup shares waiting to be dumped into the market in September. In fact, 1.8 billion shares from 45 different companies will be free to trade this month.
October is a different story, with the number dropping to around half of the September figures — reflecting the pulled IPOs dating from the bear market in May.
Any way you look at it, when you combine the lockup expiries with the pre-IPOs waiting in the wings — the NASDAQ will be buried in supply over the next three months.
Fantastic profit opportunity
This scenario presents a number of speculative opportunities to make money. The obvious way to play this supply and demand configuration is to short companies today against the end of the month and buy companies in October when the influx of supply decreases. But first, let me give you three clear examples of how this works.
Looking back over the past three months, I culled twenty stocks that act in almost perfect symmetry with this hypothetical scheme.
As you can see from the following charts, these stocks formed a perfect "V" shortly after the lockup expired (average 3 to 5 days) and insider shares were free to float. Lockups generally expire six months after an IPO, though some last an entire year. You can find this information in the SEC documents.
The companies are NetCreations Inc. (NTCR:NASDAQ), Telecorp PCS (TLCP:NASDAQ), and Vitris Technology (VITR:NASDAQ).
NTCR unlocked 11.7 million shares on May 10, 2000, representing 75 percent of shares outstanding and increasing the float by 354 percent. NTCR closed the day at US$31, but five days later it hit a low of US$24.13. If you shorted this company two months before the lockup ended (at 62) you would have made 61 percent off your short position. If you bought at the low point and sold two months afterwards, you would have made 79 percent on the long position.
| HISTORIC AND QUARTERLY RESULTS REVENUE (Thousands of U.S. dollars) |
| |
1998 |
1999 |
2000 |
| MAR |
30 |
222 |
3,746 |
| JUN |
8 |
334 |
6,086 |
| SEP |
0 |
759 |
— |
| DEC |
46 |
5,379 |
— |
| TOTALS |
84 |
6,694 |
9,832 |
| EARNINGS PER SHARE (U.S. dollars per share) |
| |
1998 |
1999 |
2000 |
| MAR |
0 |
-2.91 |
-36.49 |
| JUN |
0 |
-2.79 |
-14.32 |
| SEP |
0 |
0 |
— |
| DEC |
0 |
-17.21 |
— |
| TOTALS |
0 |
-22.91 |
-50.81 |
TLCP is the largest AT&T Wireless affiliate in the United States. On May 20, it unlocked 3.7 million shares, or 43 percent of its float. If you shorted this stock two months before at US$53, you would have made 49 percent from your short position, and 60.3 percent from your long position buying the lowest price and selling two months later.
The next unlock date for this company is August 17, 2001, when 73 million shares will be set free — nearly 800 percent of the float.
Vitris Technology worked much the same way. On May 11, 61 million shares became free to trade. That equaled 48 percent of shares outstanding and more than 513 percent of the float. You would have made 68 percent from VITR shorting two months prior and a whopping 130 percent buying the dip and selling two months later.
Perfect timing
Granted, it's been a volatile summer and stocks have been kicked around quite a bit. But by backtesting over the past few months using some fairly common valuation techniques, coupled with the big unlock dates, I was able to find 19 stocks that have had an extreme, tradable fluctuation. You could have made considerable gains in a short time with any one of them.
The average gain on the short side was 42 percent. The average gain on the long side was 85 percent. And when you consider that most of the recent unlocks are Internet companies, and that the Internet index took a big header and then went sideways all summer — those are fantastic numbers!
These are staggering results. And, as I write this, the Taipan research department is backtesting these numbers over the last decade. I can tell you that the results are more than encouraging.
In fact, I was so excited about this amazing opportunity I decided to give you, as a loyal Taipan reader, the most spectacular short play going into the tax loss selling season.
Please read on for more of Chris DeHaemer's analysis.
In addition to his duties at Taipan, Chris DeHaemer is the editor of The Hammer.
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