Issue of Short Interest in Flex Discussed Again.
(Thought this article was interesting. Enjoy. Peter.)
Dow Jones Newswires -- February 10, 2000
SMARTMONEY.COM DAILY SCREEN: Shorts And Short Squeezes
By IAN MOUNT
Smartmoney.com
(This article was originally published late Wednesday)
NEW YORK -- If you listen to chat-room denizens, you get the strong feeling that short sellers are the Linda Tripps of the investing world. They are repeatedly accused of backstabbing, they rarely appear on magazine covers and they certainly don't get invited to the best parties (even after plastic surgery).
It all boils down to the fact that short sellers' success is based on the misery of others. They borrow shares from other investors, sell them on the open market, and then buy stock later to replace the shares they borrowed. In other words, they sell first, then buy, in the belief - or, rather, hope - that a stock will see its value tumble and will be cheaper in the future.
It's a risky proposition. Despite recent volatility in the market - which has meant that even tech stocks occasionally tumble - it's been tough going for shorts.
The largest of the stock-shorting mutual funds, Prudent Bear (BEARX), is up just 1.1% this year. That's better than last year's disaster, when it lost 23.4%, but the fund still lags the NASDAQ Composite index year-to-date by 7.7%.
'It's been horrible. It's been tough to make money for short sellers because the market's acted so irrationally,' says Prudent Bear's manager David Tice. Today's go-go market 'means you've got to be a lot more careful about how you short. For us, shorting has become a lot more tactical. You can't just look at a company and say it's overvalued and it's ridiculous and short the stock.'
As we noted the last time we ran this screen, short investors make money when the market acts sensibly. And that's not how the market has been behaving lately.
But don't cry for the shorts. Bad times for them give investors who follow short trading another way to make money. It's called a 'short squeeze,' and it comes to pass when a stock that has been heavily shorted shoots up in price. When that happens, some of those who've shorted the stock feel compelled to cover their positions because they're worried that the stock may never fall back to earth. Others are forced to cover their shorts by the brokerage firm they've borrowed from, which can demand the return of the borrowed stock. As a result, the price is driven up further by surging demand when the shorts go looking for the stocks on the open market.
The bad news for investors, however, is that there is no foolproof way to know when this is happening, especially in the current volatile market. It's made more difficult by the fact that data on the number of shares shorted is available to the average investor only once a month, and that comes on a two-week delay (check out the Nasdaq site for more information).
As Tice says, 'These days, the term 'short squeeze' is used when there's a lot of shares short in a stock, and the stock just pops and seems to go up for a greater percentage than might be expected just because of a change in fundamentals.'
Using Tice's definition, we searched for companies that had been heavily shorted but had strong growth expectations, low debt, a reasonable average trading volume and share momentum that could inspire a short squeeze. Admittedly, in the eyes of some investors, every company we turned up is questionable; you don't get 10% of your shares shorted for being unblemished.
One interesting story our screen turned up is Flextronics International (FLEX), a Singapore-based manufacturer of communications, computer, electronics and medical devices for the likes of L.M. Ericsson Telephone (ERICY), Cisco Systems (CSCO) and Koninklijke Philips Electronics (PHG). In the January report from the NASDAQ, the company's short interest stood at 10.6 million shares, down slightly from 12.5 million in December. About 10% of the outstanding shares were shorted as of the middle of January.
In the midst of this heavy shorting, the company produced a 'blow-out' earnings report on Jan. 20. That led to upgrades from CIBC World Markets and Deutsche Banc Alex. Brown, along with a 20% share price rise over two weeks. Talk about the beginning of a short squeeze.
According to CIBC World Markets analyst Michael Zimm, the short interest can be traced to the company's acquisition of Dii Group (DIIG). Some shorts are probably betting that the company will have a tough time digesting Dii, he says, while others may figure that a shortage of cell-phone parts could mean lower earnings if the company can't fill its orders.
These fears are mirrored by one San Francisco-based hedge-fund manager, who says that concerns over available parts are very real on the Street. 'On Flextronics, the word is that things are soft out there for manufacturers,' he says. He points to increasing accounts receivable and inventory numbers as signs that the company has slowed down. (Those increases, however, appear small.)
Another possible explanation for the short interest, according to Bear Stearns analyst Thomas Hopkins, is that traders are shorting Flextronics because acquiring companies often slip (and the acquirees often rise, as Dii has) at the time of a merger. Hopkins has nothing but incredulity for Flextronics shorts. 'On a fundamental basis, people shorting the stock are insane,' he says. 'God help those short sellers out there.'
Should there still be heavy short interest when the next short report comes out on Feb. 28, CIBC's Zimm says, 'I'd take it as a big, big plus. Absolutely.' The reasoning goes that continued short interest could mean a continued short squeeze. Two other interesting short squeeze candidates are Aware (AWRE) and Winstar Communications (WCII). Aware, a Bedford, Mass.-based Digital Subscriber Line software licenser, had short interest of some 2.8 million shares, or 12.9% of its outstanding shares, as of mid January. Between Jan. 14, when the last short- selling numbers were posted, and Tuesday, the stock has risen 33.6% CK. A short squeeze, perhaps?
According to Charlie Pluckhahn, an analyst at Stephens, Aware has a public-relations problem that might explain the shorting: It is prohibited from talking too much about its own product innovation. Companies like Analog Devices (ADI), Lucent Technologies (LU) and Intel (INTC), which license software from Aware, want to introduce technological advancements on their own.
'Unlike some other companies in the [technology] industry, there is a lot of business they can't talk about,' Pluckhahn says. 'Their issues are much more psychological and PR-related than they are fundamental.'
There are dangers with the company, however, as with any heavily shorted stock. According to Warburg Dillon Read analyst Anton Wahlman, delays in the installation of DSL lines have made the stock price volatile, which could explain some of the shorting. Increased competition could also push down the price of the company's goods. Athough Wahlman rates the stock a Strong Buy, his target price is a modest $64, not that far above the stock's current price of around $45). Pluckhahn has a $61 price target and a Buy rating on the stock.
Winstar, a New York-based provider of private long-distance telephone and wireless broadband services (see article), has the highest "short ratio" of stocks that trade at least an average of 500,000 shares daily.
The short ratio (11.9) refers for the number of days of average trading it would take to eliminate the short interest in a stock; a high one suggests that an upward price movement could cause a strong short squeeze. Since Jan. 14, the stock's price has risen 2.8%.
According to David Barden, a J.P. Morgan analyst, the company has been a 'longtime target of shorts' because it went public 'through a back door.' In fact, the company does has an interesting past. It was born in 1993 out of Robern Industries, a company that provided a grab-bag of products and services, including private long-distance telephone services and beauty and sports products.
Still, the past is not the present, and the company hit a 52-week high on Tuesday in anticipation of its earnings report, due Thursday after the closing bell. A $900 million investment by Microsoft (MSFT) and others in December has created some excitement and has provided, 'further validation of Winstar's business model and broadband-wireless assets,' according to Friedman, Billings, Ramsey & Co. analyst Riyad Said. A positive earnings surprise could send the stock soaring and the shorts running.
As we've said before - and ought to repeat - shorted stocks almost always have an air of uncertainty around them. Though short sellers like Tice have had a tough time lately, they've done well in the past. Investors who want to make money off the misjudgments of such pros had better do their research. If they don't, they might find themselves holding the short end.
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