From the desk of Jeroen Bakker,
Benelux Consulting Lead, Pierpoint Financial
In the eighth episode of (In)Famous Securities Lending Transactions, we continue our commentary on stocks that are in play in the securities finance world. In this episode, I look at the Chinese online education company called GSX Techedu, reason for this week’s choice is that WSJ dubbed this as one of this year’s worst shorts.
So why are the hedge funds interested in this particular stock, and how did they get this so wrong, or did they? With the securities lending data provided by FIS Astec Analytics, I am going to investigate this and see what the potential losses are.
GSX Techedu Inc. is a technology-driven education company and a leading online K-12 large-class after-school tutoring service provider in China. GSX Techedu offers K-12 courses covering all primary and secondary grades as well as a foreign language, professional, and interest courses.
GSX went public on 6 June 2019 selling 19.8 million American Depository Shares (ADS) at the mid-market price of $10.50, raising $208 million valuing the company close to $2.4bn. The company is currently valued at $17bn with a stock price of $71.23 (21/10/2020)
A quick recap on the difference between an ADR and ADS: American depositary receipts allow foreign equities to be traded on US stock exchanges. An American depositary share is the actual US dollar-denominated equity share of a foreign-based company available for purchase on an American stock exchange
The share price more than doubled in the first six months of trading but it really took off in June / July of this year with an all-time high of $131.27 on 6 August. The graphs show that there have been limited opportunities to bet on a short sale. The only profitable short would have to be traded on 1 or 2 days in August when the stock price was at its all-time high.
So why is there so much interest in shorting this stock? Many of the short sellers claim that the company is a fraud (where did we hear this before?) and that the majority of their users are fake. They expect the stock to go to zero and delist if the audits are done properly. The company did confirm that they are currently under investigation by the SEC after recent allegations.
To be fair Chinese companies listed on a US exchange do have a bad reputation, and the White House administration is looking to ban these companies unless they can adhere to US accounting standards.
The latest drop in share price is due to analysts cutting the price target because of intensified competition and mistakes in summer promotions GSX made. None of the analysts is indicating anything in relation to falsely created users or accounting malpractice.
In a previous blog, I already established a pattern in fee and utilisation for IPO’s. Usually, the stock price during an IPO is very volatile and therefore, interesting for short-sellers or intraday traders. As a result, securities lending fees and utilisation will be inflated during the first weeks after an IPO. This also applies to GSX where utilisation levels drop right after the IPO but are quickly back up at the 80%-100% level. Securities lending fees are also high from the initial public offering and remain “warm” until the beginning of 2020 when utilisation and fees rapidly drop down.
At the start of April, this situation drastically changes when utilisation skyrockets in two days from around 20% to close to 90% and while it takes two months for the fees to follow suit it is only a short-term increase.
The current situation is one of high utilisation and a GC+ fee which indicates that the shorts are still on the book, but no new shorts are traded, which matches with the stock price developments. The cost of carry for short positions is around $7,000 per month for 100,000 shares GSX ($10,240,000), not taking collateral costs into consideration.
To close or not to close? That is the question.
In many shorting trade situations, timing is everything and the same applies here. For $7,000 per month, the investor can generate a potential profit of $10,240,000 if traded before the recent share price drop.
However, if the trade has been on the book since the IPO the cost of carry would have been around $150,000, the potential gain $1,000,000 (minus cost) but your current loss on paper $6,100,000.
This year’s worst short? I am not convinced; shorts traded at the first half of 2020 are definitely in trouble, and it will still take a significant share price drop to go in the black, however, shorts from July onwards are getting close to being profitable, and the trend is clearly downwards.
As with many of these cases, this is going to be one to keep an eye on, so watch this space and time will tell!!