It's starting to happen. It is playing out as I feared. Big funds are beginning to sell their high growth technology stocks to raise money to buy the coming onslaught of initial public offerings. It is behind the weakness in so many stocks today as institutions start learning of their allocations for Lyft, the ride sharing deal that comes Friday.
I have tried, in piecemeal fashion to explain what's going on behind the scenes in this market and, frankly, no one seems to believe me. So I am going to lay it all out for you so you understand what happened today and what will continue to happen now that we are in the IPO gauntlet.
Understand that behind the scenes there are a host of things going on at once. The first is that the management of Lyft is going around the country talking to potential shareholders and they like what they hear. How can they not? Lyft is part of so many of the great secular trends out there right now, the aversion of people, particularly millennials, to owning a car and the desire to ride share to save money. In a time of slowing growth it's getting easier to find drivers and these services increase in value when they have them. I know it's second banana to Uber, but their service is available to 95% of Americans and they've facilitated over a billion rides and have a 39% share of the ridesharing business with 18.6 million active rides as of December, and 1.1 million drivers. It's a very real business and one that is going to capture a nice sized share of the $1.2 trillion that is spend on transportation, spent each year in this country. It doubled its revenues last year and expanded its gross margins dramatically even as they lost almost a billion dollars last year.
The company uses all the right buzzwords: "Freedom at your fingertips, freedom from the stresses of car ownership and freedom to do and see more." The company believes many of its users are loyal to Lyft because of its "values, brand and commitment to social responsibility." As the Lyft offering document says "roads and parking lots have replaced too much green space. Mass car ownership strains our cities and reduces the very freedom that cars once provided."
Perhaps that's why they had $8.1 billion in total bookings and $2.2 billion total revenues in 2018.
Even as the company is flush with $2 billion in cash and cash equivalents, it's offering 30.77 million shares at a range of $62 to $68. They are trying to raise between $2 billion and $2.4 billion if it goes off within that range but I bet that range is raised tomorrow because of the voracious demand.
It's compelling, it fits the mold, it's going to be massively oversubscribed. So, let's stop right there and explain what that means. Individual investors may try to get some stock on the deal. Really good customers might get 100 or even 200 shares.
But most of the stock will be designated to institutional accounts that circled stock, meaning they put in, or indicated they have a desire to own as much stock as they can get. This morning these behemoth money managers, mostly mutual funds but some hedge funds, got their initial allocations and they are beginning the process of liquidating some of their current holdings, typically their stocks of other fast growing companies, so they have the capital to take in as much Lyft as the syndicate desk - the allocators of stock - allow.
Remember that most of these funds don't have a lot of cash sitting around. They also don't have a lot of money coming in over the transom. Lots of money was withdrawn from the stock market in the wake of the Fed-caused mini-bear market that began in October and ended in December.
Plus, the companies that run index funds have won in their desire to take in money that used to go to mutual funds. These funds are not able to get any Lyft because Lyft is new and is not in any indices.
So these hedge and mutual funds who are clamoring for Lyft have to be ready for whatever allocation they can get, plus be ready to buy in the aftermarket.
What does that mean?:
Lets say a gigantic fund asks for 10% of the deal - that's what you always do when you try to get a maximum allocation and it gets 250,00 shares and the deal is priced at $68, the high end of the range. Now lets say there are a flood of orders including retail orders that want in wherever the stock opens. The 250,000 allocation is typically not enough for the largest funds to make a difference. So they go in at the opening and buy another 250,000 shares. Then, because of the low basis of the first lot, the average turns out to be pretty darned good and the fund is doing incredibly well on Lyft, much better than it would if it just held on to its Workday (WDAY) or Facebook (FB) or its Alphabet (GOOGL) or Netflix (NFLX) . So those sales were good sales.
Notice I said that the big funds bought at the opening, not sold. Not only did they want that great basis but they also wanted to demonstrate to the brokers that they aren't flippers, the most hated and despised by every syndicate desk. Plus because it is at the end of the month these funds have to disclose their holdings, the brokers which gave them stock will not give them any of the next hot deal. I used to show my runs to the brokers to let the know how I didn't flip so I, too, could get as much of the hot ones coming up.
Now that's good news for all the funds that got stock on the deal. But its bad news for all of the holders of the stocks that were used as what's known as a source of funds: the cloud kings, the social wunderkinds, the biotechs, and all of the FAANG names, along with their doppelgangers.
Because the Lyft deal will make them so much money they don't care how low they sell these other stocks. So the selling will be unabated no matter what. It's just irrelevant to them.
Now I have been short-term bearish on the market - and raised a lot of cash for my charitable trust, which you could have seen if you join the Action Alerts PLUS club - because of this process. Not Lyft, but the process. I trust the process, which means I trust that this identical series of sales will occur for Pinterest, for Palantir, for Slack, for a ton of mediocre deals the brokers make you take and then ultimately for Uber, the big daddy of them all. When we get to Uber you can bet that these funds will not have a spare dime and will begin to sell anything that moves. They are going to sell health cares, they are going to sell semis, they are going to sell retailers, restaurants, anything that's growth, so they can get a as much of the deals that seem like they will hot and definitely enough Uber because retail is going to come in and make that stock open well above wherever the syndicate desk prices the offering.
When we get to Uber, if that is the last one, you can expect that buyers are exhausted and existing stocks will be so cheap that they will represent value. They may even make you more money than the IPOs. At that point and only at that point can the market really find terra firma.
So expect more days like today. Expect many of them because in the end the stock market is a market of supply and demand and there will be a wave of supply that, no matter how hot, will most certainly overwhelm demand and drive all stocks lower until the tide goes out with a whimper, not a bang.