Re: 8/28/00 - [EMLX] Cramer Rewrites 'A Maelstrom of Confusion Over Emulex'
Commentary : Wrong! Take Two
Cramer Rewrites 'A Maelstrom of Confusion Over Emulex'
By James J. Cramer
Originally posted at 1:24 PM ET 8/26/00 on RealMoney.com
Every once in a while there's an event on Wall Street that just takes your breath away. We got that event on Friday, in the form of a hoax involving a financial disaster at Emulex (EMLX:Nasdaq - news), one of the great highfliers of this era. This event captivated my firm. It felt like we were having a day at the beach when suddenly this wave came up and over our heads. We were staggered by it because we traffic in the Emulexes. This is a catastrophe in our neighborhood. This piece tried to capture the battle stations motif of the moment.
For us it all started with a 10:13 a.m. headline on Bloomberg about Emulex restating. (This should have said revising earnings downward. The dreaded postearnings revision. It immediately sent thoughts of Cendant (CD:NYSE - news) and Waste Management (WMI:NYSE - news) and McKesson HBOC (MCK:NYSE - news) and MicroStrategy (MSTR:Nasdaq - news) through our heads. We know people were paying up for Emulex because of its fantastic growth. This release revealed that the growth was phony. Instead of there being no price you wouldn't pay for Emulex, there was no price you would pay.
That kind of news shakes you to your core because you know that everyone is going to try to sell the stock, the market will be very fast, you will bury whoever you sell it to and you really can't get out if you own "size." You just have to take your lumps. Remember the gradations of declines from least painful to most: 1. Strong buy to buy on price, 2. Reit buy, trim numbers by a penny, 3. Buy to hold, and cut numbers, 4. Hold to sell and cut numbers, 5. Revise numbers downward because of accounting fraud. The last is the killer. Theoretically, if you had sold Emulex at 50 after news like that, you would still be happy.)
Matt "Don't Panic" Jacobs was on the phone jawboning some Soundview guy about LifeMinders (LFMN:Nasdaq - news). (LifeMinders had been in our office the previous week and it seemed like a compelling story, so Matt was doing more work on it, finding out what others knew about the company.) I was working on some DRAM negative story, worrying about how much money we might lose on the group because pricing ticked down a bit. (There had been some concern that DRAM prices had dropped overnight and Friday some analysts were a little more concerned about spot prices than they had been. The stocks got clipped a bit.)
I don't even remember who I was talking to but I hung up on him -- I apologize whoever it was -- and I made Matt hang up on the Soundview fellow. In fact, I demanded that he hang up or I would rip the phone out of his hand. Matt then got the release and we immediately recognized that this would crush QLogic (QLGC:Nasdaq - news). We had no hope to short Emulex. You need plus ticks to do that.
(OK, here's the crucial bit. When you don't own something and you want to bet against it, you have to wait for a plus tick, meaning that you can't sell it at a price equal to or lower than the last sale. If Emulex was trading at 89.5 bid and 89.75 offer, you would have to have someone pay you more than 89.5 to short the stock. There has to be an uptick from the last sale. That keeps you from driving the stock down as a short-seller. In other words, without this rule, you could have sold 10,000 shares short, say, at 89.5 on the bid if that was the last sale price. Or you could have sold it at 83 to knock it down. Or 81 for that matter. With this rule, if you don't first own the stock, you must wait for someone to come in above the last bid and pay that price.
As you can imagine, in this free-falling environment, nobody is going to pay you what is known as a "plus," so you don't even bother to try to short it. Could you have bought puts instead? Yes, theoretically, but no market maker would have wanted to make a market of size into that maelstrom. So you couldn't get those done, either. It was, I think, an almost impossible short on the way down. The longs were killing themselves to get out of it. There was no way you could profit from the short side.)
We nailed some QLogic puts at an outrageous price -- a colossal overpay -- within a few minutes and were down immediately on them. (When QLogic was down 8 points we knew it was going to fall a heck of a lot more. We didn't know how much, so we went in to buy some puts. We were trying to buy the September 110 puts with the stock at 100. I instructed our trader that he should get the trade done. I should have said, "Don't pay more than 12," which is where they were when we went in. Instead we ended up paying 18, as the stock rapidly fell from 100 to 93. When we were finished our buying, the stock jumped back to 105, where we averaged down at 12. Fifteen minutes later, at the height of the Emulex "disaster," we sold these puts at 24.
It was a nifty trade. Interestingly, we got 24 when QLogic was at about 79. In other words, we never got the true value of the puts. We could have bought common against them instead at that price, but the market was so fast we weren't sure we could get those prices. Better to just dump the puts and move on. If Todd had been there, we would have priced it out more, but we were short-handed and wanted to book a win.)
And then, suddenly, Emulex was down 50 points and everything started falling out of bed. When the QLogic was in free fall, we dumped the puts -- you have to sell these things before the stock bottoms -- and we focused on trimming some highfliers. (Like doctors, our first thought was to do no harm to the portfolio. Then we tried to be offensive. But the chaos was palpable and you simply couldn't get things done without forcing them and wrecking relationships. No thanks.)
We were tempted to buy NDX puts but they were on the fly too and I feared being picked off. (Again, when markets are whipping all over the place, you don't really want to go in and buy 500 NDX puts betting a ton of capital on the direction. No, we had no idea it was a hoax, but if it weren't, should QLogic really have been down that much? I thought QLogic being down that much was an overreaction. I should have been looking to buy. But in the back of our minds we had that MicroStrategy day, the day when MSTR was revealed to have played with the books. It didn't just bring down MSTR, it brought down the whole Nasdaq and was very painful.)
Next thing you know, Brocade (BRCD:Nasdaq - news) is down 12, and we called a quick audible and said to ourselves, what the heck, even if Emulex restates, it shouldn't knock down Brocade and we grabbed some. At that point, though, we hesitated because the DRAM call was making the rounds, putting additional pressure on tech.
(Here we switched from defensive -- working out of individual stocks that would get hurt -- to offensive, betting that the collateral damage was too great and it was time to buy our faves. We know that in these situations you can't wait until the stocks bottom. I always use the example of the mechanical rabbit that falls off the rail at the dog track. Hey, terrific, you can catch it, but so can everyone else, so you get nothing. If you can buy when the hell is actually breaking loose, you do much better. Everyone is waiting for the selling to end. You can't move when it does. You have to anticipate the end of the selling. We thought it was ironic that this week BRCD was such a focus for us, right down to this last day of the week.)
So we switched to buying nonhardware and tried to take some Ariba (ARBA:Nasdaq - news) playing a premium B2B firm. (We like Ariba and this one was down 6 and we figured that made no sense. Why should a B2B player get hurt by a restatement at Emulex?) The markets were thin and we weren't able to get much at all. And we dumped a little IBM (IBM:NYSE - news) for God knows what reason. (We did this horrible trade for the worst of reasons: It was up at the time. That is a sure tell of a strong performer. And we were selling strength. Shame on us. Losers!)
We also shorted some Finisar (FNSR:Nasdaq - news) because it supplies components to Emulex. (Matt "Fit & Fibre" Jacobs knows this stuff better than anyone in the business. He looked at me and said Emulex is an 11% customer of Finisar. Hey, cool, let's go. We shorted 25,000 and got someone to play us a plus at 44. Others had not figured out this relationship as fast. It dropped to 43 soon after.) Oh and we banged out some Tibco (TIBX:Nasdaq - news) badly into the vortex. (Another sloppy, dumb trade taking advantage of a stock that was up. We love Tibco. We got hurt on this and bought it back quickly at a higher price.)
Boom! The hoax got revealed about then and the whole Street was leaning the wrong way. Those who hadn't gotten out of Emulex had shorted the NDX or had shorted similar companies such as QLogic and Brocade. (QLogic had been rallying for seven minutes up until the news of the hoax broke. It had traded as low as 75 but was at 87 when the news came out. Amazing, you had to anticipate the bottom on this one all right.)
Others had banged out of an assortment of stocks as we did. We couldn't take any chances. Emulex is a huge highflier owned by high-quality people that had vaulted 50 points on the backs of the shorts, who definitely were behind this sophisticated hoax. (The news guys must hate talking about shorting, perhaps because of all the trouble I got into when I described the process on Wavephore. It's a simple construct. Someone could have bought a lot of puts on Emulex over many days and then released the bogus news, sold the puts and bought common stock all the way down, knowing it would eventually be discovered. We were cackling in our office that if the CEO of Emulex was one of those young kick-butt west coasters that comes in at 5 a.m., he could have nipped this one. But nah, he was a saunterer!)
Our first trade after the hoax was to cover the Finisar, in which we took a beating. With no Emulex problems, we had no case whatsoever to be short Finisar, which we actually like as a company. Collateral bozo damage but I would do that trade again. Any time. (Now that we knew Emulex was healthy, what the heck were we doing shorting one of its suppliers? The horror of this short caused me to lose my temper and I yelled that I wanted to limit the loss to $100.000. Fortunately, we got it in for less, but it was very tense because I sensed we could have been in for a gang-tackle short, as I'm sure others shorted Finisar soon after. Finisar is a really good company and this could have killed us.)
We tried to get more Brocade but there was none for sale. Code Red! We bought the IBM back and looked for more nonsemi names to buy but had little luck other than to scoop up a tiny amount of Veritas (VRTS:Nasdaq - news). Next thing you know, the opportunity was over. (We were doing screens for stocks down a half-dozen points or more that had nothing specific wrong with them that were in the cohort, but we had no luck. We were cooking with gas, someone else was cooking with nuclear energy though, because I got a lot of emails from people who said they bought QLogic in the break. When QLogic was at 87, I said buy 10,000 shares of QLogic and "Pay 91." But we missed it. I think that some of you took it ahead of me! Good work!)
Now we have our souvenir, a copy of the hoax release, which read so amazingly well I thought it was one of those forgeries from The Great Escape. We recognize how fragile the whole shooting match is. And we're thinking, What the heck, isn't this supposed to be the slowest Friday of the year? (It took me about an hour to get back in shape after this one. This was a brutal ruse. But we made money so I was happy.)
(I am including the release for all to read. Pretty amazing.)
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Press Release: Emulex Announces Revised Earnings
August 25 2000 9:30
SEC Launches Investigation Into Accounting Practices. Paul Folino Steps down as CEO.
COSTA MESA, CA -- (INTERNET WIRE) -- 08/25/00 -- Emulex Corp. (Nasdaq: EMLX), the world's largest supplier of fibre channel adapters, announced that last quarter's earnings will be revised and will fall short of previously announced Net income for the fourth quarter of fiscal will be revised to a loss $0.15 per diluted share, compared with net income of $3.0 million, or per diluted share, for the same quarter a year Earnings for Q4 were reported as $.25 per share, due to compliance with generally accepted accounting principles, revisions were made. Net Earnings for fiscal 1998 and 1999 will also be revised. A press release with more detail will be submitted today at 5:00 p.m. EST.
Emulex is a leading designer, developer and supplier a (sic) broad line of Fibre Channel host adapters, hubs, and software products that provide connectivity for Fibre Channel storage area networks (SANs), network attached storage (NAS) and RAID. The products are based on internally developed technology and are deployable across a variety SAN configurations and operating systems, enhancing flow between computers an peripherals.
Emulex's products offer customers the unique combination of critical reliability, scalability and performance and can be customized for mission-critical server and storage system applications. Emulex products have been selected by world's leading server and storage providers, including Compaq, EMC, Fujitsu-Siemens, Groupe Bull, Hitachi Data Systems, IBM, NEC and (sic) In addition, Emulex includes industry leaders Intel, McData, Microsoft, Legato and VERITAS its strategic partners.
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James J. Cramer is manager of a hedge fund and co-founder of TheStreet.com. At time of publication, his fund was long Ariba, Brocade, Compaq, EMC, IBM, Intel, McData Corp., Tibco and Veritas. His fund often buys and sells securities that are the subject of his columns, both before and after the columns are published, and the positions that his fund takes may change at any time. Under no circumstances does the information in this column represent a recommendation to buy or sell stocks. Cramer's writings provide insights into the dynamics of money management and are not a solicitation for transactions. While he cannot provide investment advice or recommendations, he invites you to send comments on his column to James J. Cramer.
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