A Long Short List
The introduction of The Motley Fool's new service, The Big Short, got me thinking about shorting stocks again. I was fairly heavily involved in shorting stocks in real-life during the market implosion a couple of years ago and did reasonably well with it, but by nature, I tend to gravitate towards value stocks, particularly special situations and/or companies that pay attractive dividends.
I am not currently short any stocks in real life, but I try to balance out my CAPS portfolio to make it somewhat market-neutral (like many hedge funds do) by sprinkling in a few select shorts.
Here's a few of my active CAPS shorts, some of which I have mentioned before and others that are new, along with my scores on them thus far for anyone who's interested:
Tesla Motors (TSLA) Score: -13.91
To borrow a phrase from ESPN's Mike & Mike in the Morning, I now bring you today's Stone Cold Steel Pipe Lock CAPS short. I have not come this close to attempting to short a stock with real money since I was unable to borrow shares of Moody's (MCO) around a year ago. The stock that I am so negative on is Tesla Motors (TSLA).
For those of you who aren't familiar with the company, and if you're not it likely means that you've been vacationing in a tropical island or searching for terrorists in Afghanistan without any access to television or the Internet, Tesla produces luxury plug-in electric vehicles. It is scheduled to launch its IPO today at $17/share.
As someone who has worked in the auto industry for well over a decade, I have developed a sort of sixth sense that enables me to tell with fairly good accuracy which new models / companies will be successful and which ones will fail. Ironically, I am actually rooting for plug-in electric vehicles to catch on so it pains me to say that I believe Tesla will likely die a long, slow death.
Let's look at the facts.
- Tesla was created by Elon Musk the founder of Pay Pal, not some automotive guru, the freaking founder of Pay Pal. That's like buying into a car company founded by the always annoying Mark Cuban. Not only does Musk have no experience in the auto industry, he's practically bankrupt. You can say all you want that a person's private life shouldn't matter, but when the CEO of a company is going through a nasty divorce, it stands to reason that they might be a little distracted. Musk plans to sell $20 million worth of Tesla stock in today's IPO.
- The company has never made a profit. It lost 29.5 million dollars last quarter and 55.7 million dollars in 2009.
- The only reason that Tesla is still alive and kicking after the meltdown in the auto industry is the government in its infinite wisdom decided to provide it with $465 million worth of our tax dollars at a time when the country is running a massive deficit.
- Tesla currently only has one model, a $100,000 roadster. The roadster market is limited enough, let along the market for a one hundred thousand dollar plug-in vehicle with a limited range.
- Tesla is trying to develop a $50,000 plug-in electric sedan that might be available some time in 2012 (I'll believe that when I see it). Meanwhile, real automakers are furiously working on developing plug-in vehicles that will likely be available some time later this year (Nissan Leaf / Chevrolet Volt)
- Small independent automakers don't work. There's a long list of small companies in the auto industry that were at one time successful, but were unable to go it alone in the U.S. market...Saab, Hummer, Volvo, Jaguar, Land Rover, Daewoo, etc... Eventually every one of these companies was forced to sell out to a major automaker or stop selling vehicles in the U.S. Heck even Chrysler was a dead man walking until Fiat bailed them out. There is only one company that I consider to be successful that sold as few as 20,000 units in 2009...Porsche. Porsche isn't even independent any longer. It was eventually bought out in a fascinating battle with Volkswagen. And it would be an absolute miracle if Tesla sold even that many vehicles. Small, independent automakers don't have the cost structure to compete in the uber-competitive U.S. market.
- Tesla doesn't have an extensive network of dealerships. There are currently only 12 Tesla dealers. Most people who purchase luxury vehicles want to know that they'll have some place to service them. They aren't going to want to go out of their way to drive all over the place to have their vehicle worked on or question whether the dealership that they bought their car from will even be there a year or two from now. How ironic would it be if the place that you needed to drive to to have your Tesla serviced at was further away from your home than the car's driving range. As idiotic as it sounds, with only 12 dealers, it's very possible.
There are a few things that give me pause about shorting Tesla. First and foremost as we learned in the dot com bubble, the market can remain irrational for long periods of time. It is very possible, perhaps even likely that the share price of Tesla will rise well above its initial $17/share offering price. The offering priced above its initial target of $14 - $16/share and it was oversubscribed. I'm sure that a bunch of slimy hedge funds out there with connections are chomping at the bit to flip this thing in order to make a quick profit.
The current Tesla roadster is cool looking, fast as he-two-sticks, and gets an impressive 200+ miles per charge. Those are attractive attributes, but it's one thing to build a handful of expensive, cool cars and completely another to do so in an industry (autos) that's almost as bad as the airline industry.
Toyota invested $50 million in Tesla. That money is peanuts to a huge automaker like Toyota, but still is shows that there's at least some interest there.
Tesla is also partnering with Daimler (Mercedes-Benz's parent company) to develop an electric version of its Smart car. It remains to be seen how successful that venture will be though. Smart's sales have completely fallen off of a cliff and increased competition in the A- and B-Car segment is coming on fast.
Tesla is in the process of purchasing the recently closed NUMMI factory in Fremont, California. It's difficult to say how much of this was because of the people who worked there and the way that it was run rather than the plant itself, but NUMMI has always been well-regarded in the industry. If this transaction is finalized, Tesla will have a decent place to build its new sedan, if it ever gets that far.
Ultimately, I wouldn't be surprised in the least if Tesla was ultimately bought out by a large automaker that wanted access to its plug-in electric vehicle technology. I don't think that there's enough certainty about the market for plug-ins today nor do I think that its technology is far enough along for someone to be interested in buying Tesla out in the near future, but it is possible down the road (so to speak, see the automotive reference ;) ), Between now and then, the company's share price could fall quite a bit as it burns through cash and possibly needs to do another share offering to generate funds.
I sent an e-mail to the fine folks at CAPS yesterday requesting that they add TSLA to our beloved game. It now exists. I'm going to wait a little while to see what the initial pop is like, but I plan on shorting Tesla in CAPS some time today.
InterOil Corp. (IOC) Score: +4.35
IOC has very little cash and it's burning through it at a tremendous pace.
Whitney Tilson T2 short via Market Folly.
Green Mountain Coffee (GMCR) Score: -11.04
Investors who shorted Green Mountain for any extended period of time have been absolutely crushed as the stock soared more than 1,000%, that's right a thousand percent, over the past four years.
As I search for a few select shorts to hedge my mostly long CAPS portfolio, GMCR seems to fit the bill. I use a Keurig at the office and it's not bad, but I don't think that the company will experience the rapid profit growth that Mr. Market currently seems to be pricing in.
One major headwind that Green Mountain faces is a huge increase in the price of coffee beans, which according to Barron's account for nearly a quarter of the Company's cost of goods sold. Coffee bean prices recently hit a twelve-year high:
Price no buzz kill for java lovers
Add to this the fact that the company's inventory levels are rising rapidly. As someone who has a background in the auto industry, I know that rising inventory levels are often a sign of bad things to come. Again according to Barron's Green Mountain's day's supply of product has risen to 84, from 74 from the same period a year ago.
Furthermore, while the company's revenue growth is astounding at 64% year-over-year in its most recent quarter, its growth rate is slowing. 64% is down from 77% in Q4 and 68% earlier in 2010. In this sort of economic environment, it's easy to see consumers being hesitant to pony up a premium price for the convenience of Green Mountain's coffee products, when the good old coffee pot will do the trick at a fraction of the price.
Even if higher input costs and a slowing economy don't take their toll on GMCR, the fact that the patent protection on its "K Cups" is scheduled to expire in 2012 might.
At 44 times its estimated 2010 profits, I have a feeling that GMCR has further to fall in today's weak market.
Blue Nile (NILE) Score: +9.00
Still over-priced even after recent drop. I'm looking for a few consumer discretionary stocks to short to hedge my mostly long CAPS portfolio. NILE, trading at 36 times its estimated 2011 earnings, versus 14 for a company like TIF, fits the bill nicely.
Alliance Data Systems (ADS) Score: -3.53
I have been looking for another short or two to hedge my mostly long CAPS portfolio and Alliance Data Systems (ADS) is one of the winners, or losers I suppose I should say. Barron's recently published a piece on the company titled "Industry Leader or Shaky Credit?" This is actually the third decent article that I came across in this week's Barron's. That must be some sort of record.
First a little background. Alliance Data Systems is essentially a highly leveraged credit card company. Alliance provides the affinity credit cards for a number of retailers, including stores like Victoria's Secret and Charming Shoppes
All the way back at the beginning of the credit crisis Blackstone (BX) actually offered to buy ADS for $81.75/share, but it eventually withdrew the offer. Shares of the company have bounced around ever since dropping all the way to $25/share and rising again to $78/share before settling in at its current $56.50.
Now this trade certainly isn't a secret, nearly 25% of the company's shares have been sold short, so at some point we could see a short squeeze, but a bad company is a bad company and the way the article makes it sound these guys are in rough shape.
As of March 31st, Alliance Data Systems' book Its book value was a negative $1/share and its tangible book value is negative $27/share. The company has a negative book value. Not only that but at the end of 2009 it had around $2 billion in debt versus only $1 million in cash on its books. The Company's primary source of liquidity has been a $204 million bank line of credit.
The Barron's article contends that on a sum of the parts basis, ADS is worth no more than $30/share.
ADS's credit card business appears to be deteriorating and it uses aggressive accounting practices. For example, Alliance runs a Canadian customer-loyalty program called Air Miles. ADS assumes that a whopping 28% of the points that it issues to people who are enrolled in this program will go unused. Twenty-eight percent. American Express (AXP) runs a similar type of program and it assumes that only 10% of the points that it issues will go unused.
Another example of the company's aggressive accounting is its recent purchase of a credit-card portfolio from Charming Shoppes. Once it had the portfolio on its books, it immediately revised its estimated market value upwards for a $21 million gain.
Last month ADS disclosed that it has amended the terms of a $700 million bank that it has so that it is no longer required to pay any principal or interest until the loan matures in 2012. The people who are bearish on the company see this as a sign that it is having serious financial problems.
Add a federally-mandated reduction in credit card fees into the mix and a consumer that still reeling and you have one messed up company. I recently went short ADS in CAPS at $59.09/share.
Great Northern Iron Ore Properties (GNI) Score: -30.61
I've seen this short idea mentioned several times over the past year or so, but I decided to shed some light on it here now that I'm officially adding it to my CAPS portfolio.
The name of the stock is Great Northern Iron Ore Properties (GNI). GNI is a trust that owns the mineral rights to a section of the Mesabi Iron Range in Minnesota. In April 2015, the mineral rights to this land will be transferred to a subsidiary of Conoco Philips and GNI and it will essentially be worth nothing. OK, not completely zero, but a little over eight bucks per share ($12.5 million final distribution / 1.5 million shares), a far cry from today's $88.
The problem is that GNI pays a hefty dividend that anyone who shorts it will have to doll out quarter after quarter after quarter (20 to be exact) until this puppy is dissolved. Assuming a dividend payment of $8.00 to $10.00/share, were talking about paying out between 9% and 11% annually to short this stock. This is not something that I'd be thrilled about doing in real life...but in CAPS where it's not my money let's do it.
Another problem with shorting GNI in real life is that it only has about a million and a half shares outstanding, of course once again that's not a problem here in CAPS.
Let's look at this trade as simply as possible, ignoring all of the IRR, present value, rigmarole. Barring an explosion in the price of iron ore, by shorting GNI today you will have to pay anywhere from $40 to $50 in dividends along the way and a $8.50 (rounded up) final payment in 2015. Add all of that up and we arrive at total cost of $48 to $58/share compared with today's share price of $88/share for GNI. That's a profit of $30 to $40/share on the short, not a killer return over five years...but a respectable one.
Not only will GNI be worth practically nothing by the year 2015, but it is entirely possible that iron ore prices will drop significantly in the future if the global economic recovery slows or if China implodes. A drop in the price of iron ore will lower Great Northern Iron's distributions to shareholders and make this trade less painful for shorts. Furthermore, GNI's stock tends to move in tandem with the S&P 500, providing protection of the recent market weakness continues. I like to sprinkle a handful of shorts in as protection for my mostly long special situations CAPS portfolio and I have chosen Great Northern Iron as one of them.
salesforce.com (CRM) Score: -17.88
While some of the articles over at Seeking Alpha often leave a little to be desired, many of them are pretty good. Possibly the best feature that the company has been running lately is its "Just One Stock" series of articles. In these pieces, someone at SA interviews a seasoned investment manager and asks them for their best stock idea at the moment.
Today's article in the series ties in nicely with the blog post that I wrote last week titled Cast your vote for the World's Most Overpriced Stock. At the time, I nominated Opentable (OPEN) as my overvalued stock. Another company that received a number of votes was Salesforce.com (CRM).
Here's a link to today's Just One Stock article:
Just One Stock: The Cloud Leader Due for a Return to Earth
In the article, Bret Jensen, chief investment strategist for a Miami hedge fund called Simplified Asset Management states his case for a short of CRM.
Here's what Jansen has to say about the company:
How is Salesforce.com positioned with regard to competitors?
The company is the undisputed market leader in the customer relationship management software space. However, given the growth of cloud computing and the 80% gross margins available in this space, it can count on deep-pocketed competitors - Oracle (ORCL), Microsoft (MSFT), SAP (SAP), etc. - offering compelling alternatives at some point in the future.
I am also not impressed with the product itself. I spent eight years as a technical director of software development at a Fortune 100 company. None of my contacts from my previous career that have deployed the main CRM software are impressed with its ease of use, technical architecture or overall performance. The most common feedback I have received on the software is that it is adequate, but a somewhat “clunky” tool.
How does CRM's valuation compare to its competitors?
Probably the closest comparison in cloud computing is VMware (VMW), which I think is very overvalued itself but looks like an absolute steal when stacked up against CRM:
And speaking of the CEO, does the company's management play a role in your selection?
Yes, management does play an important part of our evaluation. First, they are selling stock incessantly. CRM is consistently on Barron’s weekly top 20 companies with heavy insider selling. They also lost a key executive to Hewlett-Packard (HPQ) recently.
Finally, the CEO is famously prone to hyperbole in interviews and events. One recent interview spent quite a bit of time talking about his Zen-like management philosophy, swimming with dolphins and how he works one week a month out of his house in Hawaii. Personally, I like the CEOs for my long picks to be from the old school: nondescript, blunt and totally focused on running the business.
I am opening a short position in CRM today in CAPS at $98.11/share, or around 162 times trailing and 66 times forward earnings.
Talbots (TLB) Score: +17.06
I heard retail expert Howard Davidowitz say in an interview a while ago that he believes that Talbots will eventually be worthless and I can't disagree. The company is loaded with debt and it seems to have lost touch with its target demographic of older women. The J. Jill acquisition was terrible. It is shopping the stores now and it can't find a buyer. The only reason TLB hasn't filed for bankruptcy already is that its Japanese lenders / shareholders keep extending and pretending. Add what I expect to continue to be a tough environment for all retailers to the mix and that's one big mess.
United States Natural Gas Fund (UNG) Score: +12.00
Many ETFs are Stupid and Shouldn't Exist
Every time i hear an interview with an "investment advisor" on the radio and they say that they only invest in ETFs I cringe. I just don't get them. Sure some, like the ones that invest in a basket of actual stocks, are fine. But many of them are a complete joke. The worst of the ETFs are the ones that are supposed to track a commodity or a basket of commodities.
This week's Bloomberg Businessweek has a great article on the inherent flaws in Commodity-related ETFs and how the market's normal contango eats away at investor returns. It is a must read for anyone who owns a commodity tracking ETF, such as UNG or USO.
If I personally have an exceptionally strong feeling about where the price of a commodity is headed, I will usually attempt to play the theory by purchasing stock in a company that directly benefits from the move that I am forecasting, not by using one of the dumb commodity ETFs.
Contango should continue to erode shareholder value in UNG over time. The only way this pick loses is if the price of natural gas explodes, which I doubt will happen.
Here's a great quote on the subject from a recent BusinessWeek article:
Just as they did with subprime mortgage-backed securities, Wall Street banks are transferring wealth from their clients to their trading desks. "You walk into a casino, you expect to lose money," says Greg Forero, former director of commodities trading at UBS (UBS). "It's the same with these products. You're playing a game with a very high rake, a very high house advantage, and you're not the house."
RealD (RLD) Score: +8.50
Like most of the people in the U.S., when the current fad of introducing movies in 3D started I got swept up in it, went to see several 3D movies, and thought that they were cool. Perhaps it was nostalgia that sucked me in, thinking back to my youth when we picked up paper 3D glasses at 7-11 and watched a couple of cheesy 3D horror flicks on broadcast television.
Last year I saw a couple of movies in the theater with my older son in three dimensions, including Ice Age: Dawn of the Dinosaurs and Up!. As time wore on though, I tired of watching movies in 3D. The last 3D movie that I saw was the new Clash of the Titans. Not only was the movie not great, but the 3D aspect really didn't add anything to it...other than several dollars to the price of each ticket. I missed the huge blockbuster movie Avatar in the theaters, so I decided to watch it on Pay Per View in HD instead. I have to tell you, I didn't miss the 3D one bit.
To be honest with you, watching movies in 3D with the glasses actually makes me feel sort of sick after a while. It certainly is less relaxing than vegging out to a normal movie. Consumers Reports recently reported on this very subject in an article titled Having trouble seeing 3D?.
I have taken both of my sons to see a couple of new movies recently, including Toy Story 3 and Despicable Me. Despite the fact that both were offered in 3D, we went to their old-school 2D showings. I wasn't just that I had my doubts about whether my two year-old would be willing to keep the 3D glasses on the entire time, I just don't enjoy 3D movies...certainly not enough to justify paying several dollars more a piece for four tickets to see one.
I came across several articles on the subject today.
Hollywood fears the 3D bubble has already burst
Like RealD's Stock Price, 3-D Movies Face a Bumpy Ride
Why 3-D is already dying
Here's what a recent article in the UK's Daily Telegraph has to say on the subject:
The proportion of cinema-goers who opt to see new films in their 3D versions has fallen steadily over recent months, with more opting instead to watch them in the traditional - and cheaper - format.
When Avatar came out in December, 71 per cent of Americans who went to see it on opening weekend - often the peak moment for a new release - opted for a cinema showing the 3D version. In March, when the animated fantasy How to Train Your Dragon was released, 68 per cent of the audience chose to see the film that way.
But by May that figure for Shrek Forever After was down to 61 per cent. At the beginning of this month only 56 per cent saw The Last Airbender in 3D, and a week later the proportion fell even lower, to 45 per cent, for the newly-released animation Despicable Me.
The figures have provoked an anxious debate within the film industry, which had previously hatched plans to convert popular films on its backlist - everything from the Star Wars trilogy, to Harry Potter, to the college pranks of Jackass - into the cinematic style du jour. Studios are already working on at least 24 brand new films in the expensive format for release next year. Now some fear that the "3D bubble" has already burst.
Capitalizing on the recent euphoria surrounding 3D, a company called RealD (RLD) went public last week. The company is the market leader in installing its 3D screens in movie theaters. Despite its sector-leading market share, over rivals such as Dolby, IMAX, MasterImage, and Xpand, RealD has yet to turn a profit. I suppose the logic is, become the market leader by installing as many screens as possible, as quickly as possible and worry about turning a profit later. Its revenues have been growing at a tremendous pace, but I suspect that its revenue growth lose steam more quickly than many people think. Plus RLD is already trading at something like 3.5 to 4 times sales, which is pretty rich. The company will report earnings on August 2nd, so we'll get a closer look at how things are going for the industry then.
Perhaps I'm jumping off of the 3D bandwagon too early and it will end up being a disruptive technology like cell phones, or color television once were. Time will tell, but my disenchantment with 3D caused me to short the shares of the recent IPO RLD today at $18.70/share.
I have a feeling that it's not just me who feels this way about 3D. Does anyone else out there agree with me? I'd love to hear others' thoughts on 3D movies in general or specifically about RealD.
Short theses for "growth" companies often draw a lot of angry responses from people who love the company or its product, such as this comment that I received after my RLD pitch:
"...If you base your investments on such arbitrary things, you are sure to lose big. "
There's nothing arbitrary about shorting the stock of a money-losing IPO at what quite possibly could be the height of a fad. Since I initiated my trade in CAPS RLD has fallen over 8.5% versus a drop of just under 2% for the benchmark S&P 500. Not bad, but I expect that the stock has further to fall.
This week's Barron's contains an article on the company titled Not Too Appealing, Even in 3-D.
As one is able to tell by the title, the author believes that RealD's stock has further to fall as well.
Here are a few relevant quotes from the article:
The day RealD came public, July 16, at $16 a share, it jumped 22%. It got as high as $21, although it's since slid to around $17. But even at that price, it looks overvalued. In fact, a fair price might be $13—the bottom of the IPO's original expected range.
In fact, RealD's initial public offering last month was somewhat reminiscent of those late 1990s high-tech IPOs that ultimately led to nothing but regret for those who bought the hype and ended up with only the stock.
"The question I keep asking myself is: 'Why did RealD come public?''' says Rich Greenfield, an analyst at BTIG Research, an independent research firm. "It didn't need the money. It has no debt, and minimal capital spending relative to its cash flow." And he adds: "I suspect the IPO was more about insiders selling.''
Which, in fact, is what those insiders did. With the IPO, the company sold six million shares at $16, generating $96 million. Meanwhile, stockholders sold almost 8.4 million shares–more than had been planned – to raise $134 million. When the insiders, the supposed smartest guys in the room, are selling, it's often a signal that a stock has topped out.
By reading this article I came to find out another bearish thing about the company. I already knew that it didn't make any money and probably won't any time soon, but I didn't know that it has been issuing stock warrants to many movie theater owners who install its systems for practically nothing. These outstanding warrants create the very real possibility of dilution for existing shareholders...though I suppose that it will make the company's losses per share metric look better ;).
I am not short RLD in real-life, just in CAPS, but this will be an interesting stock to keep an eye on.
Opentable (OPEN) Score: -46.11
I've been toying with shorting Opentable (OPEN) for some time, believing that it is outrageously overpriced at this level...144 times trailing earnings. For those of you who aren't familiar with the company, it is an on-line reservation system for restaurants that is free for consumers but makes money by charging restaurants for the installation of hardware, a monthly fee, and a charge per reservation.
I recently came across a fantastic write-up on shorting OPEN by Rahul Ray from Independence Capital Asset Partners.
He believes that given that the total North American revenue opportunity for Opentable's core (electronic reservation book) business is about $470 million the company's NA business should be valued at $12 to $16/share, assuming reasonable penetration and growth rates. He adds to that $256 million in potential revenue through the Company's International business, or around $4 to $8/share and $3/share in cash and arrives at a total value of around $19 to $27/share for the company...versus its current share price of $45.
Even with 100% of all restaurants in North America, UK, Japan, and Germany participating in the company's business, which would never happen, Ray says that he can't justify valuing this stock at more than $35/share. He also sees the company's increasing reliance upon growth in Europe to drive growth as a major weakness, given the economic problems and austerity measures that are taking place there.
Now one has to keep some of these shorts in context. I probably would never put a several of those trades, such as OPEN, GMCR, or CRM on in isolation in real life. There's a lot of people out there who swear by these companies' products. It is entirely possible that all of them, or at least a couple of them will live up to the hype and grow into their astronomical valuations. However, as a small portion of a mostly long CAPS portfolio they should act as decent hedges against a significant downturn in the overall market.
Also, keep in mind that I try not to be too greedy with my short trades. I often close them out to lock in a decent gain even though I think they might still have some room to run.
I've closed out all of the following shorts over the past couple of months for decent gains:UltraShort S&P500 (SDS), iPath S&P 500 VIX Short-Term Futures (VXX), Education Mgmt(EDMC), Corinthian Colleges (COCO), ITT Educational Services (ESI), Apollo Group(APOL), KB Home (KBH), Beazer Homes (BZH), Standard Pacific Corp. (SPF), iShares Dow Jones US Home Const. (ITB), and Moody's (MCO).
The closure of these winners makes my remaining short picks appear to be skewed somewhat towards the red, but in reality I am way ahead in points when shorting. I believe that I've only closed out one negative short position thus far in 2010.
Anyhow, that's my long, short post. I'd love to hear others thoughts on either these companies or other ones that make attractive shorts right now.