Ciena delivered a great quarter by any measure, but it saw a major hit on its stock. The situation is a lesson for tech companies overall, because on the one hand companies are legally responsible to serve shareholder interests, and on the other hand Wall Street has been manipulating markets. We’re in a period where tech overall may be a slave to hedge fund greed, but it may work out in the end.
The problem Ciena had was that while it had a good quarter, it lowered full-year guidance to reflect the fact that buyers are uncertain about macro-economic issues. The old guidance predicted a 20-22% increase in sales and the new 18-22%. Obviously, all Ciena has done is admit to a potential hit on the low-end side; the new guidance range overlaps the old otherwise. An article in TelecomTV asked “Is that enough to justify an 11% share price correction?” Good question, particularly given that the market consensus on the company, as reported by Yahoo Finance, is positive in the short, mid, and long term.
OK, perhaps an admission that sales growth might dip a bit in the second half is a negative, but if there’s such an appetite for Internet capacity that telcos who can’t raise broadband prices are themselves facing a profit-per-bit crisis that might require subsidies, how can a company who provides the tools for increasing capacity be viewed in a negative light? Perhaps they aren’t.
Hedge funds, unlike ordinary investors, can not only bet on the decline of a stock to make a profit, they can actually stimulate the decline. There are various tools to do that, all collectively referred to as “short selling”. One approach is to borrow shares of a stock from a big broker who holds a lot, sell the shares, and expect to buy them back at a lower price when the stock goes down. If short-selling is used in a particular way, it can exaggerate even minor market movements. In Ciena’s case, there were probably a few investors who saw that risk of a decline in sales growth as a trigger to take some profit. Short-sellers probably jumped on the sales these investors triggered, and since stock prices are set by the ratio of buyers to sellers, that dumped the stock.
You may not see this as being something you worry about if you’re not investing, but tech companies were already sweating this short-selling thing before Ciena, and they’ll surely sweat it more now. Not only that, the problem isn’t limited to tech vendors; short-selling is IMHO a major reason why the markets have performed so badly over the last year. Tech buyers, those who are public companies, are also facing this problem.
When a company’s stock price goes down, the management team has a legal obligation to shareholders to try to sustain and grow it. Growing revenues is a great approach, but that requires a willingness of buyers to increase their spending, and if the buyers are also being pressured by short-selling, they may also be looking to cut costs. Cutting cost can equal spending less on products and services, so many vendors/providers will elect to cut costs themselves. Why tech layoffs? Maybe you should blame Wall Street.
The impact on tech here could be widespread. There are generally two pieces to the budget for tech products and services, one aimed at sustaining what’s already been justified and deployed, and one representing incremental improvements and extensions. Both these pieces can be impacted by “slow-rolling”, delaying a budgeted expense by staying with current infrastructure. New projects can also be dropped completely, scaled back, or changed to lower costs. While the risk of this happening is real, vendors have to be careful with their guidance, which can then provoke more short-selling and stock dips…and so forth. In theory, Wall Street short-selling could drive the whole economy into a recession.
There’s some good news, though. The US Securities and Exchange Commission (SEC) is investigating short-sellers, and even the threat of investigation creates a risk to the practice that’s likely to curb the most egregious behavior. I think some of that is already visible in the market, and I wouldn’t be surprised to see Ciena recover a lot of its share price dip fairly quickly. The other good news is that, to paraphrase a song, “They say that all bad things must end some day.” If you borrow stock to sell it, you have to pay a fee while you’re holding it and you have to give it back eventually. That’s called “covering your short”, and to do that, a short seller has to buy the stock at the market price (there are other complex options involving derivatives, but it all comes down to buying shares at some point). That covering can then send the shares up, so investors who are smart enough not to follow the alarming comments in the financial media will likely not only get back to where they were, they might even earn a profit from the whole deal.
The problem is that a lot of bad things can happen while we’re waiting for Wall Street to either get back to the old notion that you make money investing when stocks go up, or for the SEC to fine or jail some people who are working against the market at large. The general view of network users, for example, is that the second half of 2023 will see a relaxation of macro-economic negatives. On a fundamentals level, that’s almost surely true, but could short-selling keep driving markets down even if macro conditions improve? Darn straight, and if they do, the caution created among both buyers and sellers would be enough to derail the positive turn we could otherwise expect.
Anything that distorts the tech market hurts all of us in it. Let’s hope that either the market itself, through performance, stops this behavior or that regulators step in. Ultimately it may be up to Congress, and there is no question in my mind that the current regulations that allow things like short sales let experts make money at the expense of the average investor.