Could Archegos happen in SA?

The finer details regarding the forced selling of stocks linked to Archegos Capital Management are becoming clearer. In what could be described as the largest margin call ever for a single client, more than $50bn worth of total return swaps (over-the-counter derivatives almost identical to better-known contracts for difference) entered into by Bill Hwang’s family office were unwound on March 26.

Large blocks of shares were dumped in the market by the derivative counterparties, the prime brokerage divisions of several global investment banks. It seems Archegos had a highly concentrated portfolio financed with leverage of more than 500% and that it failed to shore up its collateral when required to do so, triggering the sales. The large selling volume caused many of Archegos’s investments to fall sharply in price, triggering further forced selling and billions of dollars of losses for those investment banks which were too slow to unwind their exposure to Archegos.

Could the same implosion happen here? Well, given the substantial risks posed by over-the-counter derivatives, more so than exchange-traded derivatives such as futures contracts, SA’s Financial Sector Conduct Authority has introduced strict regulations which require the providers of these investment products to act responsibly and to have a large enough balance sheet to cover unexpected losses without affecting other clients. The major prime brokers operating in SA are divisions of banks, which gives extra comfort regarding their ability to absorb margin call shortfalls.

Forced selling can represent a buying opportunity, if the price of the share in question falls far enough to represent good value. Interestingly, many of Archegos’s holdings enjoyed a surge in price in the months leading up to their sharp fall, calling into question whether they really were bargains.

Let’s take a closer look at some of these shares:

ViacomCBS

This multinational media conglomerate owns the CBS television network as well as channels such as MTV, VH1 and Nickelodeon. It also owns the

Paramount Pictures film studio and book publisher Simon & Schuster.

ViacomCBS shares tripled in less than four months to touch $100 on March 22, before crashing by more than 50%. The catalyst for the Archegos implosion seems to have been the announcement by ViacomCBS on March 24 that it would take advantage of the steep run-up in its share price to issue almost $3bn worth of new stock, which sent the share price into a tailspin. We estimate that ViacomCBS shares are worth about $52 a share, 16% higher than their trading level as at the time of writing.

Discovery, Inc

Discovery is similar to ViacomCBS both in terms of size (about $30bn) and in terms of being an owner of television channels such as The Discovery Channel, Animal Planet, Travel Channel and TLC. Discovery has three classes of 123RF/dazdraperma shares, and while the liquid A- and Cclass shares showed a similar trading pattern to that of ViacomCBS shares, the less liquid B-class shares have seen an extraordinary price spike. This could indicate that Archegos was caught wrong-footed in an arbitrage trade. Discovery launched its streaming service, Discovery+, in January 2021 to compete with Netflix and Amazon Prime Video. With the jury still out regarding who will win the streaming wars, our fair value for Discovery is $48 — 10% above the Aclass shares’ trading level at present.

GSX Techedu

This Beijing-based company claims to be a leading provider of online classes for students in China. Respected short sellers such as Muddy Waters Research disagree and argue that at least 70% of GSX users are fake. It’s been reported that Hwang’s fellow “Tiger cubs”— Chase Coleman and Tao Li — are also heavily invested in GSX, and that the majority of the shares available to trade were held between the three. GSX has high short interest; the stock has fallen further than any other Archegos holding and is likely worth zero if fraud allegations are true.

Tencent Music Entertainment Group

This subsidiary of Tencent Holdings can be described as the Spotify of China, since it is the country’s leading online music entertainment platform with more than 60-million paying users. The astonishing statistic is that only 8% of its total online music users use the premium paid-for service, which leaves a lot of room for growth. Tencent Music Entertainment Group’s shares have risen from $19 at the start of this year to more than $30, before dropping back to $20, which we believe represents fair value. It is a high-quality business with strong growth prospects, which makes it a compelling investment proposition.

Taking advantage of a forced seller can be profitable, but investors should remember that just because a share price has fallen a lot doesn’t mean that it offers value.

Archegos had a highly concentrated portfolio financed with leverage of more than 500%, and failed to shore up its collateral