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It's an oft-overlooked fact, but investors do come from both sides of the aisle.
While we may seem to be on the constant hunt for businesses that look poised to grow in value over the long run, investors can also make money by betting against publicly traded companies that they believe are valued too richly and whose business model may not be stable. This process, known as short-selling, allows investors to borrow and sell shares at a higher price in the hope of buying an equal number of shares at a lower price in order to negate the borrowed share position. Or, in simpler terms, if the price of a stock goes down, you make money, and if it goes up, you lose money.
Buying versus short-selling: Here's the difference
It sounds pretty simple when it's said that way, but short-selling does come with two inherent risks that you won't necessarily find with the simple strategy of buying and holding.
For starters, when you purchase a stock (assuming you're using just cash and not margin, or borrowed money), the most you can lose is what you invest. On the flip side, a stock has no upper boundary, meaning it can double, triple, or go up 50-fold if you snag a real game-changer. In contrast, short-seller gains are capped at 100% because a stock's value can't drop below $0. Conversely, losses can be infinite since, as we just stated, stocks have no ceiling on price.
The other issue is that short-selling a stock requires a margin account. This means your brokerage is going to be charging you a certain APR for borrowing money to bet against a company. Ultimately, margin costs can eat into your profits. Comparatively, buying and holding over the long term can be done solely with the use of a cash brokerage account, meaning no fees are typically involved aside from perhaps transactions fees to buy stock from time to time.
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Short-selling more often than not tends to be a tool used by short-term traders, and it also tends to be a lot riskier than simply buying and holding. Nonetheless, we can't overlook that short-sellers can, and do, make handsome profits from time to time.
Image source: Pfizer.
Short-sellers are dogpiling this Big Pharma
What's intriguing about short-sellers is what stock has been piquing their interest of late. Based on data released by The Wall Street Journal twice monthly, pharmaceutical giant Pfizer has witnessed its short interest jump by 87% over a roughly two-week period. In terms of actual shares held short, the total count jumped by 150.2 million shares. This represents one of the largest spikes in short interest in Pfizer's history.
So what exactly has pessimists all worked up? My guess is it boils down to one transformative factor -- Pfizer's impending merger with Allergan .
Pfizer has long been a pharma giant that's bet big on M&A to drive growth. This isn't to say that its internal pipeline isn't churning out winners so much as to get across the point that Pfizer likes to balance organic growth pretty equally with inorganic. In 2002 it gobbled up Pharmacia for a whopping $60 billion; in 2009 it acquired Wyeth for $68 billion; and now it's in the process of merging with Allergan in a deal that will create the largest drugmaker on the planet.
The combination of Allergan and Pfizer, which is structured as a reverse merger with Allergan "buying" Pfizer and Allergan shareholders receiving 11.3 Pfizer shares for each Allergan share held, is expected to save the combined company $2 billion in annual costs and lead to more than 100 mid- to late-stage developing drugs. By the end of the decade the aptly dubbed "Pfizergan" merger could lead to double-digit percentage EPS accretion, according to Pfizer.
Are short-sellers wrong?
But there are a lot of worries over whether the merger will go through, which is clearly being shown by the rapidly rising levels of short interest and the wide variance between where Allergan should be trading relative to Pfizer's stock and where it's currently trading.
Image source: Flickr user Thomas.
Just a few days ago, U.S. regulators at the Federal Trade Commission requested more information about Pfizer and Allergan's merger. To be clear, both sides expected such a move by the FTC, but it's being viewed by shareholders as another delay. The more this deal gets delayed, the greater the likelihood that it could be rejected, at least in the eyes of short-sellers and some investors.
Yet, the interesting thing about this merger, as is evidenced by the tempered savings expectations of just $2 billion annually, is that there's very little overlap of business segments. Pfizer is a pharmaceutical company that focuses on oncology, cardiovascular, immunology, inflammation, and other chronic and high-profile diseases. Allergan is best known for Botox, its dermatology and women's health drug portfolio, and its central nervous system drugs.
If there is an area where the FTC may take exception it's in biosimilars, where Pfizer and Allergan are both developing a handful of biologic drugs aimed at replacing high-profile branded therapies. The thing is, biosimilars are so new that the FTC may not have enough precedence to suggest that Pfizer's and Allergan's biosimilar portfolio under one umbrella disrupts competition. In other words, I don't personally anticipate the FTC having any qualms with this merger as is.
Image source: Pictures of Money via Flickr.
I also don't believe the tax inversion laws will serve as a breaking point of this deal, either. Pfizer and Allergan have followed the rules down to the fine print, structuring this as an all-stock deal and ensuring that Allergan shareholders own more than 40% of the company when all is said and done (Allergan shareholders are expected to own 44% of the combined entity). Unless Congress specifically passes a law that would alter tax inversions as we know them, which seems highly unlikely, there's no legal precedent to halt this merger.
In effect, it would appear that pessimists are getting worked up over simply having to wait for the merger to run its course. Considering the long-term growth prospects tied to this merger, as well as the monstrous and diverse product portfolio and pipeline that's to be created, I'd go so far as to suggest that short-sellers might be completely wrong here.
Only time will tell if my assessment is correct, but I believe pessimists are playing a dangerous game of what-ifs with Pfizer.
The article Short Interest in This Pharma Giant Just Jumped by 150 Million Shares -- Here's Why originally appeared on Fool.com.
Sean Williamshas no material interest in any companies mentioned in this article. You can follow him on CAPS under the screen nameTMFUltraLong, track every pick he makes under the screen name TrackUltraLong, and check him out on Twitter, where he goes by the handle@TMFUltraLong.The Motley Fool has no position in any of the stocks mentioned. Try any of our Foolish newsletter servicesfree for 30 days. We Fools may not all hold the same opinions, but we all believe thatconsidering a diverse range of insightsmakes us better investors. The Motley Fool has adisclosure policy.
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