Hikari Crash Was Avoidable

Back to Contents of Issue: June 2000

by Nick Ricciardi

[This was a letter to the editor we thought was good enough to post here. As we go to print, Hikari Tsushin's stock is in dismal straits and bankruptcy rumors are beginning. -- Editors]

More than any other large cap Internet company in the world, Hikari's biggest asset was its own stock price.

When its stock was strong it was able to: (a) recruit and attract top quality people by compensating them with stock options and other forms of equity; (b) make acquisitions and joint ventures at extremely attractive levels because everyone liked being associated with the firm due to its sky-high stock; (c) pay for those deals in stock instead of cash; (d) persuade the top research departments in Tokyo and New York to promote the stock (they, of course, were lured by the chance of banking fees that are associated with aggressive firms with high market caps); (e) access the top talent at the top investment bank and legal firms; (f) position the firm as a premier New Economy company set to revolutionize Japan.

As its stock rose, tech funds, index players, and institutional investors had to buy it. Many had little choice. This institutional interest, in turn, brought in capital markets professionals who issued covered warrants on Hikari's shares in London and sold them all through Europe to retail investors (like the proverbial Belgian dentist). The process of hedging these financial products required capital markets professionals in many of the global investment banks to buy Hikari stock as it rose and sell when it fell.

Now if you run a firm where the main asset is your stock price, you can never stand still, for unless you make exciting things happen on a daily basis (like announce deals, open stores, bring new customers on board, make new hires, get new research reports from Wall Street ...), then your stock price will stop levitating. The moment it stops rallying, it will fall. It simply cannot stand still, for if it does, speculators will no longer be drawn to it and they will take profits. However, the moment the stock starts dropping, the so-called fundamentals begin to evaporate too. This feedback effect, in turn, further reinforces the downturn in the stock price. The bubble simply bursts.

The reason Hikari was more vulnerable than most to this kind of a downturn is that it had no hard assets, yet it had a sky-high market cap. There simply is no floor price where "value" investors can mop up the stock that greedy momentum investors need to sell.

Given this background, unscrupulous short sellers can make a fortune by bringing about what might have been a natural undoing later. They can short the stock and then put out the word that the place is far more shaky than people realize. This can stop the upward momentum and quickly turn to disaster. These short sellers are the catalysts for the bursting of the bubble. They are not unlike one or two of the derivative-oriented hedge funds in Japan in 1989. They are bringing about a change in investor psychology with disastrous consequences. If the firm is shaky enough, and they are resolute enough, it is not theoretically impossible to bankrupt the entity.

My point is that anytime a publicly traded firm's main asset is its own stock, there will be reflexive behavior that will exacerbate upward and downward volatility. In such an environment there will always be players who will try to turn investor psychology -- for that is how the really big bucks are made.

Had this group of players not done this, another would have. A crash was not inevitable, though. Had Hikari been more aware of its precarious position; and had they warned investors that a crash could happen; and had they spent time acquiring harder assets that were far less correlated to their own company, and had they constantly been aware of the nature of the feedback effect of their stock price to the their so-called fundamentals, then speculators would have had a far more challenging time negatively influencing a more durable positive investor psychology. Had they done this, they would be hurting now, but not anymore than, say, Softbank.

It's not over yet. Hikari may well avoid bankruptcy. Keep in mind, many of these short sellers are (like their unfortunate counterparts, the long buyers) locked into these shares. They now need to repurchase their shorts. This will ultimately put upward pressure on the stock, which, in turn, will back the momentum players. Hikari may have its day again ... but I wouldn't bet on it just yet. Remember that things always look best at the top and worst at the bottom.

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