Broker Check

ViacomCBS and Discovery Hit by the Short Sellers

March 29, 2021
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Monday Morning QB - Market Observations:

  • ViacomCBS and Discovery – Both Drop Around 50% for the week
  • Investment Grade Corporate Bonds Off to their Second Worst Start Since 1996
  • Average Price of Gas Closing in on $3 Per Gallon
  • Current Bull Market Reaches 1 Year Old

Monday Morning QB - Market Performance:

The major indexes finished the week mixed, as investors continue to grapple with optimism for a complete economic reopening versus inflation and interest rate concerns. Small-cap stocks lagged for a second consecutive week, signaling a potential pause in their current market leadership.

Closer to home, our individual stock discipline ran into trouble from losses in both ViacomCBS (VIAC) and Discovery (DISCA).

The Dow Jones Industrial Average added 445 points finishing the week at 33,072, a gain of 1.4%. The technology-heavy NASDAQ Composite shed -0.6% to 13,138.

By market cap, the large-cap S&P 500 and mid-cap S&P 400 added 1.6% and 0.5%, respectively, while the small-cap Russell 2000 ended down -2.9%.

ViacomCBS and Discovery – What Happened Last Week?

Typically, in the MMQB, we do not discuss our specific holdings. The MMQB is our best guess on what moved your portfolio, in general, up or down for the week. If you are not in our Stock discipline, you were unaffected by the Viacom and Discovery situation.

However, last week's market loss in Discovery (DISCA) and its parent company Viacom (VIAC), needs explaining. The events from the previous week are far from usual.

On Tuesday of last week, VIAC announced the company's intention to raise $3 Billion in new capital by issuing new shares of stock. The additional money will help pay down debt while adding new content to promote the Paramount streaming service launched earlier this year.

For those not familiar with the company besides CBS, VIAC is a media giant and the home of both Paramount and Miramax studios. Releasing old content, combined with new shows and movies from one of Hollywood's largest studios, is a smart move in our stay-at-home and stream-it new world.

The streaming service was viewed as a successful addition to its offerings, and the stock price catapulted higher on the news. The announcement led the stock price higher by better than 40%, adding to an already strong start to the year. VIAC was up around 170% year to date before the announcement on Tuesday.

Price dilution is the outcome when more shares become available. Typically, this does not result in a catastrophic event.

However, both VIAC and DISCA have watched their share price go down around 50% from Tuesday through Friday.

Part of the problem is fundamentally trying to value a "value stock" from the media sector entering the streaming business but competing with Amazon and Netflix, companies in the technology sector.

Combine that with a short squeeze, and we have a problem.

Without getting too wonky, let us address the speculation that drove the stock prices down.

Introducing the Short Sale

Enter the short sale.

First, Mike and I do not engage in selling short as an investment strategy for our clients.

However, it is a widely accepted investment strategy. It is extremely helpful to stock prices in general, although often vilified for strange pricing events. (That is a whole other subject which we will not cover here).

What is a short sale? Let's start with the mechanics.

First, the short seller does not actually buy the stock. The stock (or other security) is "borrowed" from the broker at a set "short contract price", the stock price at the time it was borrowed.

The short seller must return the borrowed stock to the broker at the broker's request or when selling the stock (called closing out of the short position).

The short seller hopes to close out the position by buying the stock at a lower price than the short contract price to repay the loan and make a profit.

The repayment of the borrowed stock is called "covering the short position." The lower the stock price falls, the higher the gain for the short seller.

If this is confusing, it is ok. Shorting a stock goes against our human nature. We typically do not buy something hoping it will lose value.

What VIAC Management May Have Missed

The bottom line is, whatever VIAC management hoped to gain by raising more money from selling additional shares, they gave up in market capitalization and at the direct expense of the shareholders. 

Let me try to explain the perfect storm that was created.

As discussed already, when the company announced the creation of additional shares, they likely knew the price would drop.  

Further aggravating the situation, according to CNBC, some significant hedge funds/family owned offices, who were shareholders of VIAC, had bought a large number of their shares on margin.

Buying on margin means they took out a loan against their portfolio to buy more shares. As the price of VIAC dropped, the hedge fund/family owned office were required to repay the loan on Friday.

This is known as a margin call. To cover the loan, they sold shares of VIAC, adding to the drop in price.

The stock market reaction centered around the executives at VIAC, seemingly indicating that they believed the share price may be too high. They wanted to raise money by capitalizing on the higher price before it naturally dropped.

The question is did management know that their stock was highly shorted? At least for now, family owned offices do not have to disclose their investment positions but there are other indicators to watch. 

The Short Interest Ratio is used to help determine how heavily shorted a stock is versus the stock's trading volume. 

The short interest ratio is calculated by dividing the short interest in a stock by the average trading daily volume (how many shares of a stock change hands on an average day). The short interest ratio also indicates the number of days, based on the trading volume, it would take to cover all the current short positions.

The short interest ratio is typically impacted by news events which leads us to VIAC's issues last week.

The short-interest ratio before the announcement last week was exceedingly high. VIAC was one of the most shorted stocks on the market. The short sellers were waiting for the price to drop from the dramatic run-up from which we profited.

The perfect storm of a highly shorted stock with a now diluted share price resulted in a loss of roughly 50% in four days.

Selling begets selling, and the short sellers made large profits, unfortunately at the expense of the shareholders.

Looking ahead, the stock usually finds a bottom as the short interest ratio falls.

Hopefully, the stock will rebound some before its likely removal from our portfolios at the beginning of April when we adjust our seven stock positions to hold for the month.

Sometimes specific risk, i.e., company risk, can reach up and bite you when you least expect it. Our stock portfolio continues to perform well year to date but last week certainly took a bite out of the year-to-date gains.

As a quick reminder, no MMQB next Monday; we do not write the MMQB following Easter Sunday. It has nothing to do with this week's news.

As always, we welcome all questions, and if you want a further explanation of what happened last week, we are glad to go deeper with you.

Have a great week!

(sources: all index return data from Yahoo Finance; Reuters, Barron's, Wall St Journal,,,,,,,, Eurostat, Statistics Canada, Yahoo! Finance,, Chaikin Analytics,,,,,,, W E Sherman & Co, LLC)
Hayden Royal is an investment adviser registered under the Investment Advisers Act of 1940. Registration as an investment adviser does not imply any level of skill or training. The information presented in the material is general in nature and is not designed to address your investment objectives, financial situation or particular needs. Prior to making any investment decision, you should assess, or seek advice from a professional regarding whether any particular transaction is relevant or appropriate to your individual circumstances. This material is not intended to replace the advice of a qualified tax advisor, attorney, or accountant. Consultation with the appropriate professional should be done before any financial commitments regarding the issues related to the situation are made.
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