Investors betting against Snap Inc.’s (SNAP) stock were given a further boost yesterday. Shares in the parent company of messaging app service Snapchat fell 4 percent after a Nomura analyst claimed that daily active user growth in the first two months of the second quarter declined 22 percent year-over-year, despite rival firm Facebook (FB) reporting rising Instagram downloads during the same timeframe.
Ihor Dusaniwsky, head of research at financial analytics firm S3 Partners, claimed that this latest sell-off was worth $39 million to Snap’s growing band of short sellers, bringing the total profits that they’ve made year-to-date to an impressive $52 million. However, with an increasing number of investors now betting against the stock and IPO rules restricting the company from releasing further shares until later this summer, he adds that the costs of funding this position have soared. (See also: What Is Short Selling?)
Source: S3 Partners
Shorting Snap Becomes More Expensive
Investors keen to bet against a particular company borrow its stock from a broker, before selling it at its current market price. When the stock becomes heavily shorted, as is the case here, the amount of shares available to borrow narrow, making them increasingly costly to bet against. This scarcity has been made more profound by rules restricting recently listed companies — Snap debuted on the New York Stock Exchange in March — from issuing new shares. (See also: Lock-Up Agreement.)
“With short interest over $1 billion there are not many shares left to borrow and the cost to finance short positions has increased from 1 percent fee in early May to 37 percent-40 percent fee on existing stock borrows and over 50 percent fee on new stock borrows,” said Dusaniwsky in note. “It’s now costing over $1 million [per] day in stock loan fees to finance all of Snap’s short positions.”
Release of New Shares to Prompt Another Big Wave of Short-Selling Pressure
Dusaniwsky adds that this conundrum is likely to continue until Snap is freed of its post-IPO commitment. At the end of July and August the company is expected to release 1.2 billion extra shares. Once supply picks up again, Dusaniwsky believes that borrowing costs will return to the original 1 percent fee, prompting another wave of sharp short-selling interest in the stock.
“With Snap shares becoming easier and cheaper to borrow we can also expect more short demand as traders who might have been reluctant to borrow stock at levels above 30 percent fee, might find the net of financing Alpha more profitable at a 1 percent borrow fee,” he said.
Dusaniwsky notes that Facebook and Twitter’s (TWTR) stock prices both plummeted after they released new shares following their respective IPOs. He expects a similar scenario to unfold at Snap, particularly as many investors — just over 50 million of the company’s shares have been shorted —paid big to short the stock when borrowing fees were high.