Usually I ignore most of these events since they rarely affect my portfolio. Sudden pressures on a stock's price also attracts the attention of day traders (which I am not) since they can profit from the short-term volatility and trading volume that these events often initiate. For example, this morning RIM became "trader bait" after announcing their quarterly results. If you check out their stock chart you'll also notice that the price was at a precarious point where it was poised to make a monumental move up off support or down to new intermediate-term lows. As of this writing, it is bouncing higher, but that could change. It is also no coincidence that the price was at that decision point since it is fully reflective of the uncertainty of holders of the stock and anticipation from potential buyers and short-sellers.
However my interest today is to talk about another company that popped onto my screen earlier this week when they announced unexpected news, and how that affected the share price: Level 3. I hesitated when I saw their name show up in the pre-market news on Tuesday since, being the telecom I am, I knew the company and wondered what was going on. It turned out they were issuing $175M in convertible debt instruments to raise funds for general operations. This moved the market because that represented ~11% of their market cap at the time of the announcement and Level 3 has a sad history of carrying a disproportionate debt burden that has bled the company of operating income. The interest rate and conversion price also promised to pressure the stock downward.
The question then becomes, just how much should the stock price move in response to this news, assuming that there is some rationality in the market. Yet you won't learn this from the stock's subsequent moves. Like throwing an electrical switch, the circuit's change from one voltage level to another is fast, but not instantaneous, and there are confounding high-frequency transients, overshooting, undershooting, ripple and, finally, damping before the voltage settles in to its new level. News like that from Level 3 is much like throwing that switch, except that the ultimate post-news share price level is not nearly as predictable as in an electrical circuit. The combination of uncertainty, company history, size of the debt offering and lots of trader interest promised a wild ride. This is just what happened.
The increase of trade volume was enormous on Tuesday, and was somewhat lower on Wednesday as it entered its "damping" phase. Further contributions to my switch analogy are the slight rise before Monday close (before the announcement was made), two sharp spike downs (at the open and close on Tuesday) and a ripple that gradually subsided, but is still ongoing to a degree. There is no natural or rational new price level just as there was none before the announcement. Everyone, except the day traders, is calculating and guessing, and also wondering what everyone else thinks the price ought to be.
Even if one were to assume that, in the long-term, that the "convertible senior notes" are fully dilutive to the stock, this would lower the share price by that amount, which in this case is that aforementioned 11%. If you are very bold, or naive, and assume that Monday's closing price of $1.16 is a rational price that reflects all aspects of the company's assets, debt and enterprise value, Tuesday's close should have been about $1.05. It actually closed at $0.95. By the end of Thursday, two days later, the price did rise to $1.00 but this is still low by 5%. It seems there is doubt in the minds of investors and traders that the previous $1.16 price represented fair value.
I am not going to attempt to justify any particular price for Level 3 shares: it is beyond my competence and interest, and would in any case be highly unreliable, just like Level 3's business prospects. This is a damaged company that has been fighting its self-created devils for the past decade. I've been to their Broomfield, Colorado offices numerous times and it can be a bit spooky since there are hall after hall of empty dark offices that reminded me of a ghost town. They have a real business, but one that is still suffering a hangover from the dot-com era.
It is also worthwhile to understand where all that sudden trading volume comes from. There is a certain amount coming from natural buyers and sellers -- investors and institutions that hold their shares for an extended period -- but a lot of the volume comes from short-term traders, many or most of whom start and end the trading day in cash. They may each make numerous trades during the day, lured by volatility and volume to eke out a few points per trade, but they will hold zero shares by the close or shortly thereafter. This is a good reason that, if you are more interested in a long-term investment, to ignore the intra-day activity and focus on the closing price since that is more reflective of investor activity. You will likely find that in the majority of those intra-day transaction that one or both parties are traders; in effect they are acting as intermediaries between natural buyers and sellers, and attempting to profit from doing so.
Getting back to Level 3 itself, I have no idea what the share price ought to be now, and I had no idea what it ought to have been before the news. The price activity tells me that others are in the same boat. Some investors hope for better times while others believe the company is ultimately doomed by its debt burden or perhaps by competition from Akamai among others. This is a stock that is heavily infused with strong beliefs on both sides, fueled by enormous uncertainty. These are treacherous waters for small investors such as myself.
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