Most investors are pleased when the price of stock they own goes up. After all, the goal is to make money by buying low and selling high.
But some investors play the game in reverse. They like to bet that a company’s stock price will fall. And the further it falls, the more money they make.
These speculators are called short sellers, and they make their money by borrowing stock first and buying it later. Here’s how it works:
Let’s say a short seller believes that a stock now trading for $10 is about to head south. He borrows 100 shares from his brokerage and sells them on the market for $1,000. If the price later drops to $9 a share, he buys 100 shares to give back to his brokerage and pockets a $100 profit, less commissions. If he’s wrong and the stock price goes up, he loses.
Recently, the Securities and Exchange Commission and the National Assn. of Securities Dealers began an inquiry to see if short sellers have been illegally manipulating the stock of American Continental Corp., causing the price to drop 47% in a little more than a month.
From the perspective of American Continental executives, the mere fact that the two agencies are looking into the matter confirms their long-held view that short sellers have been wreaking havoc with the Phoenix-based firm, which works in real estate development and savings and loan operations.
American Continental’s primary asset is Lincoln Savings & Loan Assn. in Irvine, one of California’s larger S&Ls; with $6.8 billion in assets. The folks who own American Continental and Lincoln have had frequent run-ins with state and federal regulators over the S&L;'s unconventional strategies for making money--or at least for trying to make money. The company reported a $36-million loss for the third quarter last year.
Fed up with trying to operate within a regulated industry, American Continental has been trying to peddle the savings institution. A deadline for completing a proposed sale to an investor group headed by longtime S&L; executive Spencer Scott of Glendale recently elapsed. But a new group headed by John Rousselot, a former U.S. representative from California, stepped forward last week to ask state regulators for approval to buy Lincoln.
Meantime, American Continental’s stock price has fallen from $6.875 per share on Feb. 3 to $3.625 per share on Friday, a 47% decline.
Rumors of the demise of the Scott deal appeared to be partly responsible for the stock price decline. But the SEC and the NASD, as well as American Continental, suspect that short sellers had something to do with it too.
From mid-December through mid-February, short sellers had borrowed and sold more than 825,000 shares of American Continental stock, said Enno Hobbing, an NASD vice president.
The NASD, which supervises trading in American Continental stock, considers a normal short position in any company to be roughly equivalent to the average number of shares traded during 1 3/4 days. In American Continental’s case, that would be about 37,500 shares.
“For this company, about 20,000 shares a day are traded, so the (current) short position is the equivalent of more than 40 days of trading,” he said.
Such activity among short sellers doesn’t surprise some analysts.
“That’s one company everybody has loved to short,” said James Wilson, an industry analyst with Sutro & Co. in San Francisco. “American Continental is a Phoenix-based home builder, and all the bad press on the Phoenix and Arizona real estate market has led investors to short its stock.”
What concerns the company and NASD is that short sellers could manipulate the stock price by spreading bad rumors--possibly false ones--about the company. The speculators could supply enough bad news to analysts, money managers and brokers that few investors would want to buy the stock--unless the price dropped drastically.
“Pushing the price down is harmful to our shareholders because it affects the value of their stock,” said Robert J. Kielty, the company’s general counsel. Directors and management own more than half the stock.
While the stock price alone may not affect the company’s effort to sell Lincoln Savings, he said, the negative information in the marketplace could still be detrimental to the S&L.;
Lincoln and American Continental certainly don’t need to see any more bad rumors flying around. There already is enough real fodder from self-inflicted wounds.
Ostensibly an S&L; holding company, American Continental is really a complex real estate development firm with scores of subsidiaries.
Many industry analysts don’t even bother to track American Continental to see if it might make a good investment for their brokerage clients. While companies the same size often have 10 or more analysts covering them, American Continental has only two.
“It’s a complex company with large holdings in land and in other high-risk areas that we find hard to analyze,” said Allan G. Bortel of Shearson Lehman Hutton. “Generally, it pays to stay away from that, and the market doesn’t put a high value on those companies. We stay with more traditional, conventional S&Ls.;”
There have been battles with regulators over an unusual 2-year examination and disputes over the S&L;'s unconventional activities, ranging from ownership stakes in real estate projects and other companies to currency trading and investments in high-yield “junk” bonds.
The company’s $36-million loss for the third quarter of 1988 effectively wiped out its profits for the first half of the year. The company blamed the quarterly loss on a decision not to record a profit from a stock swap, a decision influenced in large part by the SEC’s wishes.
In fact, the company has never been able to post a profit through traditional S&L; activities. So little of Lincoln’s operation is involved in traditional home lending that the interest it earns on such loans falls far short of covering the S&L;'s expenses. It needs gains from unconventional activities to post profits.
In December, government regulators determined that Lincoln didn’t have enough capital, which serves as protection against losses, to support its operations. The company is contesting that conclusion in further talks with the government.
American Continental has not released its financial results for 1988, but Kielty said it expects to do so by the end of the month. Kielty would not say what those earnings might show.