There's risk to any investment, and that includes esports company FaZe Holdings (FAZE -3.42%). However, we're watching one of the company's risk factors play out in real time today. And as of 11:20 a.m. ET, FaZe stock was down a whopping 33% and down more than 50% in less than a week.
Yesterday, FaZe filed a Notice of Effectiveness with the Securities and Exchange Commission (SEC). The company came public already via a special purpose acquisition company (SPAC). But most of its shares weren't allowed to trade until the Notice of Effectiveness was filed. And it previously had a series of edits to make with its registration documents before it could make this happen.
SPAC stocks have interesting structures because insiders typically own the majority of the shares outstanding. That's the case for FaZe as well, and it gets a special mention in its registration filings. Under the section entitled "Risks Related to Our Securities," management notes that 76% of shares outstanding belong to "Selling Holders" -- private investors and insiders whose shares will now be able to trade.
The dynamic I'm describing is common among SPAC stocks, and it's why most have failed to beat the market in the past couple of years. However, FaZe's selling holders aren't necessarily selling today just because the Notice of Effectiveness has been filed -- indeed, many shares are subject to lockup periods.
That said, these selling holders don't necessarily need to sell for the impact on FaZe's stock price to still be felt. Again, from the risk section, all that needs to happen is for it to be "perceived that they will be sold in the public market" for there to be an adverse effect. And that appears to be what's happening today -- shareholders are selling before selling holders do.
It's impossible to know right now whether today's panic is an overreaction or if FaZe stock is close to a bottom. This is why I continually advocate for assessing business fundamentals over stock price, because the former tends to drive the latter over long time periods.
That said, I personally wouldn't invest in FaZe at this stage of its business. In the first half of 2022, it's only generated $34.6 million in revenue, its gross margin is just 30%, and its loss from operations is $16.9 million. Even if esports turns out to be an attractive sector, I'd wait for FaZe to prove it can scale up its business before investing.