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BUSFIN 4224 - Behavioral Finance Professor Justin Birru Strategic Management Case Study - Fall 2018

1. a. The current stock market valuation of Creative Computer and Ubid as of December are $232,930,493.3 million and $326,429,387.1, respectively. These values were calculated by multiplying the stock price of each company by the outstanding shares as of December 9th, 1998. b. Based on these valuations alone you would expect Ubid to have more in assets than Creative Computers since it has a higher market capitalization. However, the parent company, Creative Computers, has much more in assets compared to Ubid. Going a step further, Ubid has a negative book-to-market ratio which indicates that it is more overvalued than Creative Computers, whose B/M ratio is .208. This is an example of irrational behavior and indicates that markets are not efficient – if markets were efficient, this increase in mispricing would not exist past the announcement date. Below are the calculations: Creative Computers: BV = 142,831 – (75,877 + 2,969 + 15,336 + 29 + 154) = 48,466 B/M = 48,466/232,930 = .208 Ubid: BV = 6,048 – (4,760 + 871 + 2,709) = -3,292 B/M= -3,292/326,429 = -.010

Recommendation: Elena should long Creative Computers and short Ubid since they are undervalued. 2. a. Elena should diversify and not put “all of her eggs in one basket”. Nonetheless, she should probably invest more of her money in Creative Computer. Although Creative Computer has a lower valuation than Ubid, they have a positive stockholders equity. The issue with investing in Ubid, is that they have negative stockholders equity. It is also stated in the article that although Ubid is generating revenue, yet they are not generating profits. This is an issue for equity holders, including Elena, as they will not be receiving returns on their investments. It is therefore safer to invest solely in Creative Computer. b. The risk associated with this strategy of investing everything in Creative Computer is that Elena would be putting “all of her eggs in one basket”. This means that Elena would be putting all of her money into one company and if they do poorly, Elena will face losses. For every 1 stock of Ubid that she shorts, Elena should long at least 1.569 stocks of Creative Computers. To make a profit, she should long more of Creative Computers than what she shorts Ubid for. ii.

Shorting stock is very expensive and difficult to do in the real world. This will

cost Elena as well as pose huge risks. Because losses are potentially unlimited with shorting, Elena would be exposed to that risk when shorting Ubid – there is a chance that it becomes further mispriced instead of decreasing in value. There is also recall risk – that is, the lender of Ubid stock may recall those shares before Elena has a chance to make a profit on them. It is costly because there are lender fees and rebate rates associated with

shorting. Because of these, this position may not prove to be as profitable as expected.

3. a. An example of mispricing during the internet bubble involved a company called Pets.com. This company burned a lot of cash in a short amount of time around $300 million in less than two years Their stock prices were as high as $14 per share yet fell to less than $1 when the bubble burst. To exploit the mispricing, an investor could have shorted the stock once the mispricing was noticed. Eventually, when the price of the stock falls, he or she will profit from the sale. Sources: (https://brainmates.com.au/brainrants/pets-com-a-classic-example-of-product-de velopment-failure/). (https://money.cnn.com/galleries/2010/technology/1003/gallery.dot_com_busts/) b. A second example of Internet bubble mispricing was the example talked about in class regarding AppNet Systems. The company filed for an IPO (APPN) and before it even hit the market, the company that currently had that ticker symbol began generating returns of 142,757% even though nothing had fundamentally changed about the company. This was the result of the IPO announcement and investors at the time were simply looking for Internet related companies. To exploit the mispricing, if caught in time, one could long shares of the currently listed APPN and sell them before the IPO - this is based on the assumption that the price would continue increasing in value because of the noise trading surrounding the stock.

1.

Valuation

i.

The current market stock valuation for Creative Computers is approximately $232.93 million,

while the current market stock valuation for Ubid is about $326.429 million. These values were calculated by multiplying the stock price of each company by the outstanding shares as of December 9th, 1998. ii.

Based on these valuations alone you would expect Ubid to have more in assets than Creative

Computers since it has a higher market capitalization. However, the parent company, Creative Computers, has much more in assets compared to Ubid. Going a step further, Ubid has a negative book-to-market ratio which indicates that it is more overvalued than Creative Computers, whose B/M ratio is .208. This is an example of irrational behavior and indicates that markets are not efficient – if markets were efficient, this increase in mispricing would not exist past the announcement date. Below are the calculations: i.

Creative Computers:

1.

BV = 142,831 – (75,877 + 2,969 + 15,336 + 29 + 154) = 48,466

2.

B/M = 48,466/232,930 = .208

ii.

Ubid:

1.

BV = 6,048 – (4,760 + 871 + 2,709) = -3,292

2.

B/M= -3,292/326,429 = -.010

2.

Recommendation

i.

Elena should long Creative Computers and short Ubid since they are under- and overvalued,

respectively. i.

For every 1 stock of Ubid that she shorts, Elena should long at least 1.569 stocks of Creative

Computers. To make a profit, she should long more of Creative Computers than what she shorts Ubid for. ii.

Shorting stock is very expensive and difficult to do in the real world. This will cost Elena as well

as pose huge risks. Because losses are potentially unlimited with shorting, Elena would be exposed to that risk when shorting Ubid – there is a chance that it becomes further mispriced instead of decreasing in

value. There is also recall risk – that is, the lender of Ubid stock may recall those shares before Elena has a chance to make a profit on them. It is costly because there are lender fees and rebate rates associated with shorting. Because of these, this position may not prove to be as profitable as expected....