Margin calls are one of the most harrowing elements of stock trading. During a difficult situation — often a market crash — an investor’s funds become insufficient to maintain their current positions. With prices already at seemingly wacky levels, investors are compelled into further selling to satisfy their broker. These sorts of spirals often are responsible for the most stunning market drops.
And Alibaba (BABA), Oracle (ORCL), and Tesla (TSLA) are all potential victims.
Usually, it is individual investors or hedge funds that get hit with margin calls. But sometimes corporations see their stocks plunge due to unanticipated insider selling. The CEO margin call may not be a common occurrence, but they happen frequently enough that investors in TSLA, ORCL, and BABA should beware.
Chesapeake: A Recent Example
First, an historic example from a few years ago. Former Cheasapeake Energy (CHK) CEO Aubrey McClendon died in a tragic car accident last week. This followed the US government bringing charges against him for alleged bid-rigging. It was a shocking end to one of the oil patch’s leading entrepreneurs.
But for Cheasapeake shareholders, McClendon’s run was a mixed blessing. He was notorious for lavish pay packages, totaling $100 million in 2008 alone, along with some odd deals. For example, he sold his personal map collection to the company for $12 million. Most oil companies don’t also invest in collectibles.
Most notably, McClendon, ever-the-optimist on his firm, had bet his personal fortune on CHK shares. He owned a huge quantity on margin. In October of 2008, he owned more than 31 million shares of Chesapeake. Two days later, it was almost all sold to meet margin calls. Chesapeake shares plunged 40% that week.
The board was aware of McClendon’s loans, but did not approve his forced sales. McClendon apologized for the sales, but his credibility was badly damaged. He’d later leave the firm.
Valeant: Another Recent Victim
Valeant Pharmaceuticals (VRX), the star-crossed Canadian drug company, is another cautionary tale. Shares tumbled from above $250 to under $100 in just a couple of months. This set off margin calls, and forced CEO Michael Pearson to dump stock.
Pearson had lent almost 1.3 million shares to Goldman Sachs (GS). Pearson used the funds from this loan to contribute to Duke University and also purchase more VRX stock. If an executive has large unrealized capital gains, there’s appeal to loaning your stock to donate to charity. Selling directly forces you to pay tax now instead of later.
But with the benefit comes the risk. Pearson was forced to sell his VRX shares as prices declined. His obligatory selling sent VRX shares down 14% in a single day. Shareholders take significant risk as long as these types of loans are outstanding. Who is at risk now?
BABA: $2 Billion Personal Loan
The Chinese online retail firm Alibaba is a current example. BABA top executives Jack Ma and Joesph Tsai borrowed $2 billion against their holdings in Alibaba stock. The stated reason for this was to fund their own hedge fund.
There’s nothing wrong with this in theory. It’s dangerous for a founder to leave all their money tied up in the company after going public. Accidents happen to even great firms. There’s no shame in someone like Bill Gates slowly diversifying his stock holdings by liquidating Microsoft (MSFT) stock.
However, using margin loans does make things slightly more risky for shareholders. BABA stock has had a rather poor run since the IPO. Management promised not to sell BABA shares into the lock-up to try to avoid discouraging the shareholder base.
Using a stock loan allows them to technically honor their word. In practice, though, those shares are now held as collateral at big banks, and could be dumped suddenly into the market should BABA stock resume heading lower and Ma and Tsai fail to post more collateral.
ORCL: The Biggest Borrower
The single biggest share lender is Larry Ellison, founder of Oracle. Ellison has lent roughly $11 billion in ORCL stock as collateral for personal loans. This borrowed stock accounts for roughly 7% of Oracle’s total outstanding shares.
Ellison has been criticized by some for his “profligate” spending. Among other things, he’s purchased 97% of the Hawaiian island of Lanai. He also owns a tennis tournament, a sailing team, and one of Bono’s guitars among his many assets.
With his net worth hovering around $50 billion, the $11 billion loan isn’t a huge concern now. If his net worth collapses to the point where his Oracle shares became endangered, there’s a good chance ORCL stock would already have cratered anyways.
One potential concern is succession. Ellison is up to age 71 now. At some point his estate will pass on, and his personal loans may be met by selling sizable blocks of ORCL stock. There’s generally more liquidity in the market for ORCL shares than in large private Hawaiian islands.
Other Companies At Risk
According to Reuters, there are several other companies with large stock pledges outstanding. Among them are Estee Lauder (EL) and AutoZone (AZO). These two have been stock market successes where leverage has likely aided its insiders’ fortunes nicely.
FedEx (FDX) chairman Frederick Smith came under fire in 2013 for his large personal loans, which exceeded a quarter of his total holding. Shareholders brought a proposal to try to ban FedEx executives from pledging stock. However, as of late 2015, FedEx remains one of the companies whose stock is heavily pledged out to cover personal loans.
TSLA is another current example. Elon Musk has borrowed against a significant portion of his TSLA stock to fund his various business endeavors. Please see my previous TSLA article for more discussion of that specific case.
Finally, Clean Fuels (CLNE) is one that may be most likely to go wrong soon. Energy prices have fallen sharply, taking stocks down with it. T. Boone Pickens, famed oil investor, is a heavy shareholder and co-founder.
Pickens already sold several million shares last fall, sending shares down significantly. If shares keep dropping, banks may liquidate more of his shares. This wouldn’t be new territory for Pickens. In 2008, his $165 million donation to Oklahoma State University ran into trouble since he pledged it as hedge fund shares that, in the interim, lost value in a wrong-way bet on oil.
Watch For Margin Loans
There’s nothing inherently wrong with stock loans. It’s not a common activity, but there are logical explanations for it at times.
Still, caution is the order of the day. A company with a large block of pledged stock has a built-in catalyst for trouble. At a time when shares are already dropping rapidly, a company may see an unwanted deluge of shares spew out onto the market from a cash-poor executive. It’s a risk factor to pay close attention to. Margin calls can send a stock sharply lower in a hurry.
At the time of this writing, Ian Bezek was short shares of Chesapeake Energy. He can be reached on Twitter at @irbezek.
