AMTD Digital, Meme Stocks And Reflexivity (NYSE:HKD)

Financial services platform AMTD Digital (NYSE:HKD) has shot up 23,649% since its IPO, achieving a $342.64 billion valuation. It’s now more valuable than the 489 companies listed on the S&P 500. In response, the company issued a “Thank You” note to investors. We discussed the company’s prospects in a prior piece, noting that the company is a “quality company going public in the wrong era.” Today, the company is likely one of the best bets of the decade, another example of the power of Reddit investors to drive values way past their fundamentals. AMTD is now a meme stock.

On Meme Stocks and Investing

George Soros believed that fundamentals were in constant interaction with their market price and that market valuation could make a business more likely to succeed or fail. This is a little bit more nuanced than Benjamin Graham’s notion of value. Let’s take Hertz (HTZ): Investors who looked at the company and saw a firm on the precipice of disaster were not wrong. New Constructs, for example, noted the company’s secular profit decline, declining return on invested capital – ROIC, deceptive accounting practices, and other things, in urging investors to stay away. None of those things changed. What changed is that meme stock investors backed the company, and that enabled the company to emerge from bankruptcy, giving shareholders a payout, something that Andrew Glenn, managing partner of Glenn Agre Bergman & Fuentes said he had never seen before. AMC Entertainment (AMC) also was very clever in exploiting its status as a meme stock to revitalize its business, all the while building a bond with its retail investors to keep the price elevated. So you have two things, the fundamentals of a business and what the market thinks about that business. Well, what the market says about a business can change the fundamentals of that business, just as we expect fundamentals to affect the firm’s long-term valuation.

What does this have to do with AMTD? The fundamentals of the business have changed: More valuable by 21,000% since its IPO, the company is able to do things that it could not do previously. It can pay off existing debt, it can negotiate with partners for more favorable deals, it can invest in R&D, and the company could even raise more capital at a much reduced cost. The company is stronger today than it was the day it was listed. Soros’ reflexivity theory is not very fashionable today, but meme stocks, I believe, are an example of why investors need a more nuanced appreciation of markets.

Here’s the thing. AMTD’s 21,000% price appreciation is unsustainable. The company now has a free cash flow yield of 0%, and a price-to-earnings ratio of over 14,830. If management believed that the company was worth anywhere near that valuation, they would have priced the company much more richly. If the market is “right” about the company’s valuation, then management grossly undervalued the company. Management’s response to its popularity has been to say that,

“To our knowledge, there are no material circumstances, events nor other matters relating to our Company’s business and operating activities since the IPO date. The Company is also monitoring the market closely for any unusual trading activities or abnormalities, and would continue to maintain our communication channel wide-open to the public through our Investor Relations Office.”

That note tells us that nothing has changed since the company went public. We don’t have to revisit the fundamentals. They’re the same. What has changed is the degree to which the market has fallen madly in love with the company.

What investors should expect is that management uses this mania to enhance fundamental value, perhaps at the risk of shareholder dilution, but this enhancement of fundamental value will not be so large as to bridge the obvious gap between fundamental and market value. So even with a rise in fundamental value, there will be this dislocation and the result of that will be a collapse in the price. Soros’ reflexivity theory is in line with research by Lily Francus on meme stocks.

Supply and Demand

AMTD Digital is 97.1% owned by AMTD IDEA Group (NYSE:AMTD). This means that at times when demand for shares in AMTD Digital is high, the very limited supply of shares shoots up in value. We should probably expect the stock to be very volatile given the limited share offering available to the public.

What To Do About AMTD?

Soros appreciated the fact that in “reflexive processes” the market could be wrong about the fundamentals, but that didn’t stop him from joining with the crowd and investing with it. He called these “fruitful errors.” In other words, he would invest in bets he knew were wrong-headed, because he sensed that market enthusiasm was so strong that he could still profit. The important thing would be having a clear exit strategy to abandon the ship when the bubble burst.

Investors who bet on the company early on should, in my view, either sell or have a very hard and clear line for when they will exit the stock. Recognize the fertile error of investing in the stock.

Those who did not invest in the stock have missed out on a huge win, and are likely suffering from a massive dose of FOMO. Is there any room for more growth? Should they invest? Although it’s easy to say, “It can’t go any higher” – well, it can. Nobody knows.

One thing is certain: The AMTD’s underwriters, AMTD Global Markets Limited, Livermore Holdings Limited, Eddid Securities and Futures Ltd., and Eddid Securities USA Inc., will exercise their option to buy 2.4 million shares at $7.80 per share, at a cost of about $18.7 million, and sell them for around $6 billion, assuming the price doesn’t collapse to its IPO price. That would make the underwriters the biggest winners of AMTD’s IPO.

Interestingly, one of the underwriters, AMTD Global Markets Limited, is a subsidiary of AMTD IDEA Group, which was up 500% on Tuesday alone. So this has been a great deal for AMTD IDEA Group.

Given the size of AMTD IDEA Group’s shareholding, AMTD Digital is incapable of acting against shareholder interest. AMTD IDEA Group may feel that it’s worth diluting the shareholder base if they can raise additional funds to enhance fundamental value. Trimming their ownership will not seriously affect their control over the company. Certainly, management has to capture as much of this unexpected value as it can before the bubble bursts. Hertz was very clever at exploiting the mania to improve its financial position. This of course may create a conflict between the interests of shareholders today, and those of future shareholders, and this will lead to many conversations about what management should do.

Conclusion

Yes, AMTD Digital is in a bubble. However, as Hertz and AMC have shown, smart management can exploit an opportunity like this to strengthen its business so that even when the price falls, the fundamental value and therefore, the long-term valuation of the business is much stronger. This leaves investors with a tricky road ahead. The price is unlikely to survive at this heady height, but, if management plays smart, the company will be stronger for this than it was when it was listed. If you own shares in the company, then you should have a clear exit strategy, and execute it ruthlessly when the occasion comes. Then, wait for the floor, and reinvest in the company at a saner price. If you haven’t invested in the company, then you might consider it, but you will need to have a much tighter exit strategy than an existing shareholder, because the odds of similar gains are very low. Indeed, for investors, the stock has become much riskier even though the fundamental value could potentially rise. Therefore, it’s necessary to increase risk management now. The biggest winner from this is AMTD IDEA Group, and its subsidiary, AMTD Global Markets Limited. Now, AMTD Digital has to lock in some of the value from this crazy period.