Why Short FANG Stocks According to Famed Silicon Valley Startup Investor Chamath Palihapitya

 

       Chamath Palihapitya is the founder, chairman, and CEO of Social Capital, a Venture Capital firm bases in Palo Alto, California. Chamath began his career as an early executive at AOL, Mayfield Funds, and subsquently Facebook wherefore he accrued his first fortune. Chamath is notably referred to as the Warren Buffett of tech investing due to his firm's exclusive allocation within emerging internet technology startups, and its staggering 29 % average annual returns.

        Recently, Palihapitya stated in an interview in a CNBC interview with Andrew Ross Sorkin that he expects new taxes, regulation, and anti-trust laws at every level of government to eventually relegate FANG companies to more modest valuations. He then added that competition from industry disruptors and innovators may increase this burden, especially with the president already contemplating the ratification of an executive order characterizing Alphabet as a monopoly in violation of Sherman Anti-trust laws. The greater competition in addition to increased taxes and regulation will hobble 'big tech' as a result in the coming years according to Palihapitya, it is only a matter of time. “Big Tech’s long term success is no longer about better products,” Palihapitiya said in a Friday tweet. “They are incumbents and their success is now a multi-variate/multi-dimensional problem of competition, anti-trust, tax and regulatory multiplied by EVERY city, state, country and jurisdiction in which the operate.” 

    Palihipitya's conviction that government is intimidated by 'big tech' is not untrue as the House Judiciary Committee launched an anti-trust investigation June 2019, whose findings were indecisive, later prompting a renewl of the probe and hearings this year by the Senate GOP and House Democrats alike. Additionally, shortly proceeding the hearings as expounded upon previously, the president passed an executive order authorizing an investigation regarding whether Google exists in violation of Sherman Anti-trust law. Finally and most importantly, states like Massachusetts, Connecticut, New York, and California are taxing streaming service membership fees and search engine AdSense revenue at increasingly ever higher rates. We cannot refute Palihapitya's logic as evidenced by current events which only act to further vindicate his prediction, with each new hostility and encroachment by Washington against Silicon Valley.

Energy, Industrials, and Consumer Discretionary: Opportunities in Chapter 11 Bankrupcties Among Deflated Sectors

The rate of chapter 11 bankruptcy filings increased by approximately 43% since December 2019 as of June 3 this year and persists to rise with ostensibly no end in sight. Industrial, energy, and consumer discretionary companies constitute the vast majority, or collectively 83% of bankruptcies this year. This manifested as an unprecedented oil price war between Saudi Arabia and Russia in conjunction with travel restrictions and lockdowns in many states and provinces across the world, a lack of industrial equipment, materials, and machinery demand by manufacturers that supply consumer discretionary companies whose annualized revenues plummeted 26.3% by Q2 of 2020 following a growing consumer preference for online shopping and the commencement of quarantine which ultimately exacerbated this trend.

Consequently, innumerable opportunities now exist where one can acquire shares in NCAV companies at a significant discount by purchasing their second lien notes which rank highest in the capital structure and convert to often an excess of 95% of the restructured company's equity. Concurrently, the selection of distressed companies prone to bankruptcy in this process must be limited to those whose total assets exceed total liabilities and confer a high tangible book value. Debt-laden and negative tangible book value companies cannot ensure creditors remuneration as the cost of their bonds will exceed the asset value of their position in the newly restructured company, (e.g., CHK 7.8 Billion Asset - 11.7 Billion Liabilities = 3.9 Billion Excess Liabilities, OAS 2.8 Billion Assets - 3.5 Billion Liabilities = 0.7 Billion Excess Liabilities). 
   The vast majority of companies including those whose assets exceed their liabilities pursue the deflation of assets listed on their balance sheet so as to satisfy creditors of whom managements frequently collude with, often preceding the chapter 11 filing when establishing a prepackaged deal and during the restructuring process. For example, Whiting Petroleum reported a net property and equipment value of $7.3 billion in Q3 of 2019. This asset valuation was later reduced to $3.4 billion in Q1 of 2020 due to impairment incurred from lower oil prices. Whiting's disclosure statement assumed a $1.55 billion enterprise value, an approximately 48% decline from the previous year when it was $2.96 billion. This implies that the Whiting's NCAV or liquidation value of property and equipment was less than $900 million, given its now substantial credit facility. Therefore, Whiting Petroleum's assets were deflated by nearly 65%, a stifling contrast from the valuations suggested by the balance sheet. A second example is Breitburn which filed for chapter 11 bankruptcy in May 2016 and whose assets exceeded liabilities by $1.3 billion on its Q1 balance sheet only months prior. Breitburn's bankruptcy asset valuations were more than 50% less than those presented in its balance sheet. Denbury Resources which was previously expounded upon in a recent post exemplifies a high asset value company whose tangible book value exceeds its current share price. Denbury's management recently filed for chapter 11 bankruptcy and intends to apportion the equity of the restructured company primarily among its second lien noteholders. The company's current asset values postulated within its balance sheet will presumably undergo significant deflation comparable to Whiting's, ranging from potentially 50% - 70% in the restructuring process to provide second lien noteholders with additional equity and account for low oil prices. As a result, Denbury Resources' second lien notes may be acquired for approximately 0.45 cents on the dollar, or potentially much less if oil demand sees a resurgence preceding the distribution of equity in the new company. Information regarding Denbury's Second lien notes which comprise 76% of the company debt can be found at the following link: https://finra-markets.morningstar.com/BondCenter/BondDetail.jsp?ticker=C610055&symbol=DNR4117942

SPACs: Risk Arbitrage with Special Purpose Acquisition Companies Long and IPOed Companies Short

SPAC or special purpose acquisition company are essentially blank check shell companies such as Chamath Palihapitiya's Social Capital Hedosophia Holdings II & III, or IPOB and IPOC respectively and Bill Ackman's Pershing Square Tontine Holdings, or PSTH.UT intended to acquire a high growth private company for a subsequent IPO listing, reminiscent of a reverse merger. IPOB is seeking to merge with a small-cap tech company whereas IPOC and PSTH.UT are both targeting large-cap tech companies; though Ackman's PSTH.UT is contemplating a potential partial acquisition if determined more profitable. This is reflected by IPOB's, IPOC's, and PSTH.UT's market capitalization of $560 million, $1.1 Billion, and $4 Billion, respectively. Bill Ackman stated recently in an interview with David Rubenstein that Pershing Square Tontine Holdings will restrict its search to mature innovative companies, private equity portfolio companies lacking vital liquidity, and family-owned businesses bereft of essential capital, exclusively those of which that confer attractive balance sheet, impeccable financial health, low debt, sustainable cash flows, and increasing operating margin. Conversely, Chamath Palihapitiya is famous for his high growth, and not yet profitable tech company IPOs, such as that of Virgin Galactic which was 'launched' through a SPAC in October 2019 and persists to operate at a deficit. Thus, both IPOB and IPOC will presumably result in the formation of overvalued and initially unprofitable technologies company with inflated P/E in excess of 30. 

   
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  Comparable to conventional mergers and acquisitions, shareholders in the beneficiary of these deals which is likely to be the SPACs as purported by their proprietors, Pershing Square, and Social Capital will liquidate their position in the merged, or acquired company as was observed in the Virgin Galactic, or SPCE IPO shortly proceeding its listing on the NYSE where from October 18 to November 29, it declined by $3.13 to $7.25 per share, an approximately 30% loss. This is a common occurrence among many mergers and acquisitions according to Guy Wyser-Pratte who in his 1975 book, Risk Arbitrage suggested that many short-term shareholders in the acquired or benefiting company seeking to secure their profit, sell their shares in the new or merged company immediately upon listing or once the merger is finalized. A rally often encompasses the company benefiting from the deal preceding its closure until the benefit or consequent discount relative to the price it is presumed to be acquired for, or likely to gain is arbitraged away. Thus, one might initiate an initial long position in any of the preceding SPAC IPO of a multiple of 100 shares, or more if optimistic as to their future growth potential, write OTM covered call options, sell the options continually until the profit negates or exceeds the cost of the shares (obviously utilizing technical analysis or charting tools to ensure precise timing as rallies frequently subside within weeks or months of the listing, then cyclically recur before the merger), write ATM puts for new stock of merged company during first weeks of listing when short-term shareholders are liquidating(again utilizing technical analysis or chartings tools, etc.), and finally await the short term appreciation of the remaining stock held in the merged company, assuming Palihipitiya and Ackman create value for shareholders in these SPAC IPOs as achieved in their previous ventures, (e.g. Virgin Galactic, or SPCE which appreciated by an excess of 200% from its IPO in October to February 19).

Oil: Futures Arbitrage and Protective Collars with Distressed Companies

Oil futures persist to trade in contango proceeding their historical decline to negative prices on April 20. This presents an arbitrage opportunity where one can buy the overabundant commodity now, enter into a futures contract, and sell on a later date at a significant premium. Conversely, one might be incapable of completing such a trade due to brokerage account restrictions, or other complications. Therefore, if one is seeking to capitalize on this opportunity, but unable to perform the arbitrage, then they can simply acquire shares in an oil company, such as DNR with a protective collar or merely protective put-options. Denbury Resources which trades at $0.25 was $1.02 preceding the pandemic and supply war between Russia and Saudi Arabia; thus, if it reverts once the quarantine ends and ordinary trade relations resume, the OTM Call option will negate the ITM Put option insuring the positions, or the appreciation in share price should exceed the cost of the protective put options.

Commercial Real Estate: CMBX 6 Short, RLGY Buy - Short The Debt Long Term, Buy The Equity Short Term

The CMBX 6 is a commercial real estate index composed of a laddered portfolio of BBB MBS and inferior issues. Presently, the current pandemic laws preclude the occupation of office space, malls, and public areas by companies; thus, commercial real estate will inevitably persist to decline with its pace only exacerbated by the quarantine. To short the CMBX 6, one must acquire CDS for the MBS that compose its lattered portfolio. Contrary to institutional investors, the acquisition of CDS for these MBS is restricted for individual investors, so a more viable method is to simply short the CMBS ETF which tracks the CMBX 6 and other commercial real estate indices.

Realogy Holdings was at $2.30 per share on March 18 and is now trading at $5.76, an excess of a 100% appreciation. Realogy Holdings was expected by innumerable analyst to exceed $12.00 a share as it expanded its profit margin and increased its FCF. The short term sentiment for this stock is optimistic cognizant of its recent prospects and effective capital deployment, but the long term performance of this company is uncertain considering its distressed Altman-Z Score of -0.08 and the state of the commercial real estate industry with employers now increasingly contemplating a transition to a work from home modus.

5 Ways the United States can Resolve It's $25.7 Trillion Debt

Firstly, an immediate tax rate increase proceeding a stable period of economic growth and recovery in conjunction with the minimization of expenditures by terminating or defunding social programs and decreasing the national defense budget.

Secondly, a steady or gradual tax increase proceeding and during a period of growth and recovery with the preceding method's conditions reiterated. 

Thirdly, the United States could potentially nationalize its colossal debt which constitutes approximately $78,000 for every citizen residing within its confines. However, reminiscent of Japan in the late 1990's, the United States may likely lose its credibility if it pursues this method; thus, rendering it unable to contract additional debt for the subsidization of governmental operations.

Fourthly, the United States might simply contract more debt or further refinance its federal assets and the future of the United States economy to subsidize the amortization of its interest payments, comparable to a homeowner incapable of paying their mortgage that consequently refinances to secure capital which they use to merely cover the interest for an unsustainable period.

Fifthly, an excess of 50% of the United States national debt is domestically owned and it is primarily owned by intragovernmental agencies; thus, the United States could merely forgive part of its own debt and force domestic creditors to accept a default or forgive the loan. This solution requires no policy change and permits the United States to maintain its current fiscal irresponsibility; though, it is unlikely to ever be adopted as many of the domestic owners of this debt, such as financial institutions and investors possess significant sway in Washington.