Hedge fund guru David Einhorn says he sees a bubble in the tech sector, and he’s selectively shorting a basket of tech plays he thinks are very overvalued.
“Now there is a clear consensus that we are witnessing our second tech bubble in 15 years,” Einhorn writes in a letter to Greenlight Capital investors (h/t Yahoo! Finance’s Breakout) . “What is uncertain is how much further the bubble can expand, and what might pop it. In our view the current bubble is an echo of the previous tech bubble, but with fewer large capitalization stocks and much less public enthusiasm.”
Einhorn cites several signs that the bubble is “pretty far along”. Among them: The rejection of conventional valuation methods; short-sellers having to cover due to “intolerable” mark-to-market losses; and “huge first day IPO pops for companies that have done little more than use the right buzzwords and attract the right venture capital.”
Einhorn criticizes analysts and companies for “pretending that compensation paid in equity isn’t an expense because it is ‘non-cash.'” He also says he’s shorting a basket of “bubble stocks”. Using a basket “makes sense because it allows each position to be very small, thereby reducing the risk of any particular high-flier becoming too costly,” he says, adding, “In the post-bubble period, people stopped talking about valuing companies based on eyeballs (average monthly users), total addressable market (TAM), or price-to-sales. When the re-rating occurred, the profitable former high-fliers again traded based on P/E ratios, and the unprofitable ones traded as a multiple of cash on the balance sheet. Our criteria for selecting stocks for the bubble basket is that we estimate there to be at least 90% downside for each stock if and when the market reapplies traditional valuations to these stocks. While we aren’t predicting a complete repeat of the collapse, history illustrates that there is enough potential downside in these names to justify the risk of shorting them.”