6 The Big Short II
Let's dive into the 1930s, an era distinctively different for the stock market. Before the U.S. Securities Exchange Act of 1934 came into effect, let's just say things were... somewhat less regulated. Post the 1929 crash and the ensuing Great Depression, it dawned on everyone that a change was imperative. But prior to this, the regulatory landscape was notably lax.
In that era, acquiring a substantial portion of a company's stock didn't come with the declaration requirements of today. The market was akin to the Wild West, riddled with insider trading and market manipulation. Why? Simply because there were barely any rules to curb them. Transparency in stock ownership and transactions was virtually nonexistent.
However, 1934 marked the dawn of a new era. The Securities Exchange Act was enacted, overhauling the entire system. It introduced regulations demanding greater disclosures, particularly for significant company share acquisitions. This act revolutionized the market, ushering in transparency and striving to level the playing field by curtailing numerous unfair trading practices.
Fortuitously, it was July 1932 for me, and the markets were in turmoil. Stock valuations had plummeted continuously, but I sensed a shift towards stabilization. My short-selling escapade was nearing its end, but I wasn't concerned. There remained ample opportunities to amass a... let's say, a substantial fortune. The strategy was simple: invest in companies bound for valuation hikes and sell at the opportune moment. This was a long game, spanning a couple of decades. But hey, I was young and time was a luxury I had.
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In just over two years, a lot had happened. My academic journey was on a roll – I was halfway through my Ph.D. Program in Genetics. My days and nights were engulfed in the enigmatic yet enthralling world of genetics. And the seminars? Picture a sneak peek into the future of science – a medley of emerging genetic technologies, computational biology, with a sprinkle of biomedical engineering. Because why limit ourselves, right?
My Ph.D. dissertation was breaking new ground, delving into DNA's role in heredity. Remember, it was the 1930s; the scientific world was just beginning to realize DNA's importance. I was navigating theories that luminaries like Avery, MacLeod, and McCarty, and later Watson and Crick, would unravel in the '40s and '50s. My Master's thesis on the Genetic Basis of Heredity and Mutation had laid a solid groundwork. Now, my Ph.D. research hypothesized DNA as the key molecule in heredity. And get this – all this while I was on the cusp of turning 18.
Switching gears to finance. Remember our short selling stint with United States Steel (X) shares, leveraged at 100:1 back in November 1929? When your starting capital is a cool million rather than $15,000, the earnings are... let's just say, significantly amplified. 'MWAHAHAH...'
"Alexander, why that creepy grin again?" Natalia inquired, her hand resting on his forehead.
'I'm really worried about him. Sometimes, I catch him talking to himself in his room. Maybe it's just a phase. He seemed to breeze through puberty, unlike the nightmares my friends describe with their sons.'
"Just excited about today, Mom," Alexander replied, aiming for nonchalance.
"We're almost there, so it's best to keep a cool head now." Joseph advised.
Upon entering Mr. Hamilton's opulent, more upscale office—a testament to his professional success—we received a warm welcome. "Greetings, Mr. and Mrs. Sterling, and Alexander," he said with a hint of enthusiasm. "Your visit has been much anticipated."
Joseph and Natalia nodded politely, "We appreciate your hospitality, Mr. Hamilton."
"So, are we set to close your short position on the United States Steel shares?" Mr. Hamilton inquired.
"Yes, indeed," Joseph confirmed with a nod.
Mr. Hamilton promptly turned to his phone, issuing directives to his team. "Proceed with covering the short on United States Steel," he commanded, his voice echoing efficiency and focus. The office buzzed with subdued excitement as his associates swiftly acted on the instructions.
After a flurry of brisk communications and confirmations, Mr. Hamilton put down the phone and faced the Sterlings, a glimmer of triumph in his expression. "The short position is now covered," he announced. "Market conditions were in our favor, and our timing was spot-on."
The Sterlings leaned forward, eager for the details of their audacious financial strategy. Mr. Hamilton paused, reviewing the final figures in his ledger, then looked up with a controlled smile. "Taking into account all expenses and taxes, your net profit stands at an extraordinary $68,640,106," he declared.
The amount seemed almost ethereal in its enormity. Joseph and Natalia shared a look of amazement. Alexander, typically composed, couldn't resist a broad grin.
"Remarkable," Joseph uttered, his tone blending awe and contentment.
Natalia, the family's emotional anchor, added softly, "This far exceeds our wildest dreams."
Mr. Hamilton, seizing the moment, steered the discussion towards future prospects. "With such significant gains, have you pondered your next investment move?" he asked, his gaze shifting from Joseph to Natalia, and finally resting on Alexander.
Joseph, acknowledging his son's critical role in their financial schemes, turned to Alexander. "What's your take, son? What direction should we aim for next?"
Alexander, always a step ahead in his thinking, pivoted the conversation. "Before we dive into future investments, I'm keen to know our current position in Stark Industries. Over the past two and a half years, what stake have we secured?"
Consulting his notes, Mr. Hamilton answered, "To date, your investment initiatives have secured a 5% ownership in Stark Industries."
Alexander quickly calculated. "So, with an investment of over $200,000 for that stake, we're essentially appraising the company at around $4 million, right?"
Mr. Hamilton affirmed with a nod, then added a critical point. "That's a fair approximation. However, it's crucial to note that Stark Industries' shares have seen a downturn in the past two years. Currently, the company's actual worth is slightly below $4 million."
Alexander's strategic mind swiftly moved to the next element of their financial jigsaw. "Mr. Hamilton, have we identified the other stakeholders in Stark Industries? Can we directly approach them to purchase their shares?"
Prepared for such inquiries, Mr. Hamilton confirmed, "Indeed, we have a comprehensive analysis. The other shareholders, excluding Howard Stark Sr., initially had a 13% share in the company. But with your recent 5% acquisition, their share has reduced to 8%. Notably, throughout the market downturn, Howard Stark Sr. has not liquidated any of his company shares."
Alexander's wasn't surprised about Howard Stark Sr.'s reluctance to sell his shares. "That's typical Stark Sr. for you," Alexander mused. "He's got immense pride in his company. Selling shares would suggest a lack of faith in its future – an admission he's unlikely to make."
Shifting the conversation, Alexander brought up a recent headline. "Did anyone see the news about Howard Stark Sr.?" he inquired, engaging his parents and Mr. Hamilton. "He's constructed a luxurious townhouse at 890 Fifth Avenue in New York, reportedly costing $300,000."
Alexander understood the future historical importance of this location, destined to become the Avengers Mansion under his grandson Tony's stewardship. He continued, "This move appears as a bold declaration in these economic times. It's as if he's openly defying the impact of the Depression."
Joseph reflected thoughtfully. "It seems like a facade, a way to maintain appearances. Such extravagance now could be Stark's strategic move to project an image of stability."
Alexander continued, "That's precisely why an investment opportunity might be appealing to him. It would demonstrate confidence to the shareholders."
Mr. Hamilton, contributing to the strategy, added, "Indeed, Stark places high value on the perception of strength. Publicizing a major share sale as a strategic initiative could actually help stabilize the company."
"Right," Alexander concurred. "Our first step should be to secure a deal with Mr. Stark. If he learns we're approaching other shareholders first, he might interpret it as a hostile move, even a takeover attempt. I propose negotiating for a 40% stake, though that might be ambitious given Stark's desire to maintain control. We should realistically target at least a 30% stake. It's crucial that we finalize and legally bind our agreement with Stark before proceeding with any other negotiations."
Joseph, grasping the nuances of the plan, leaned in. "So, once we've struck a deal with Stark..."
"We act quickly and under the radar," Alexander interjected. "The key is to approach the other shareholders immediately after finalizing the Stark agreement. We need to act before our deal becomes public knowledge, which might sway their selling decisions."
Natalia, following the plan, added, "And this has to be a well-coordinated effort. If the shareholders start communicating among themselves, it could throw a wrench in our plans."
Alexander agreed, "Exactly. Hesitation on their part will force us to issue an ultimatum. Delay is our enemy here. We might also consider offering a premium for their shares, but it must be carefully calibrated to avoid suspicion. The declining market trend is our ally, and emphasizing it can make our offer more attractive, especially since many are already inclined to sell in the current economic climate."
Natalia added, "The goal is to convince them that accepting our offer is their best option in these uncertain times."
Mr. Hamilton, understanding his role, nodded. "I'll start the preparations. Setting the right price point will be crucial."
Alexander summed up their strategy, "Ultimately, our success hinges on speed."
.
.
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Quick Maths:
1. Initial Deposit & Leverage: With an initial deposit of $1,000,000 and a 1:100 leverage, the total value of stocks you can short sell is $1,000,000 x 100 = $100,000,000.
2. Number of Shares Sold Short: At an initial stock price of $166 in November 1929, the number of shares you short sold is $100,000,000 / $166 ≈ 602,409.64. We'll round this to 602,410 shares, as you can't sell a fraction of a share.
3. Brokerage Fees: The total brokerage fees will be 602,410 shares x $0.50 = $301,205.
4. Stock Borrowing Rate: This is an annual rate. You held the stock from November 1929 to July 1932, which is approximately 32 months. The annual interest on the borrowed amount ($100,000,000) at 3% per year is $100,000,000 x 3% = $3,000,000. For 32 months, this would be $3,000,000 x (32/12) ≈ $8,000,000.
5. Covering/Buying Back the Stocks: When you cover the short in July 1932, the stock price is $22. The cost to buy back the shares is 602,410 shares x $22 ≈ $13,253,020.
6. Gross Profit: Your gross profit is the difference between the initial value of the stocks when shorted and the cost to buy them back. Initial value = 602,410 x $166 ≈ $100,000,060. Gross Profit = $100,000,060 - $13,253,020 ≈ $86,747,040.
7. Net Profit Before Taxes: Net profit before taxes is the gross profit minus all expenses (brokerage fees and stock borrowing cost). Net Profit Before Taxes ≈ $86,747,040 - $301,205 - $8,000,000 ≈ $78,445,835.
8. Capital Gains Tax: The capital gains tax is 12.5% of the net profit. Tax ≈ $78,445,835 x 12.5% ≈ $9,805,729.
9. Net Profit After Taxes: This is your final profit after all expenses and taxes. Net Profit After Taxes ≈ $78,445,835 - $9,805,729 ≈ $68,640,106.
TL;DR
- Number of Shares Short Sold: 602,410 shares.
- Brokerage Fees: $301,205.00.
- Stock Borrowing Cost: $8,000,000.00.
- Cost to Buy Back the Shares: $13,253,020.00.
- Gross Profit: $86,747,040.00.
- Net Profit Before Taxes: $78,445,835.00.
- Capital Gains Tax: $9,805,729.38.
- Net Profit After Taxes: $68,640,105.63.
