SWIMMING DOWNSTREAM WITH
THE SHORTS
Emboldened short-sellers are betting that this is the year the bubbles will burst
The global sell-off of recent months brought tears to the eyes of investors
everywhere. Short-sellers were also weeping--with joy. One noted short-seller, the
Dallas-based Prudent Bear Fund, saw its bull-whipped performance reverse abruptly
in the third quarter, climbing 22%--and sending it to the top of mutual-fund rankings
for that period. The market's mid-December pullback similarly gave short-sellers a
new lease on life. All this market action is making short-selling awfully
tempting--particularly for those high-flying technology and Internet stocks. ''I think
they're a pyramid scheme of the highest order and will all come crashing down
sooner or later,'' says Prudent Bear portfolio manager David W. Tice.
If that happens, shorts can win big. Short-sellers borrow stock in the hope that they
can replace the borrowed shares with cheaper stock and pocket the difference. This is
a risky strategy even in less volatile times, because shorts often are in danger of being
''squeezed''--forced to replace their shares when the market climbs or for other
reasons. Some stocks are difficult or even impossible to borrow and thus cannot be
shorted at all.
However, short-sellers argue that crummy or grossly overvalued stocks eventually
collapse. And the numbers seem to bear them out. Of the 10 stocks cited by
short-sellers in BUSINESS WEEK's midyear appraisal of short-selling (BW--June
15), nine have been crushed over the past few months. Shorts profited by correctly
forecasting, for example, that sewing-machine maker Singer would be hurt by its
exposure in less-developed countries. Sure enough, its already beaten-down share
price has been cut nearly in half since June.
Shorts such as Tice are betting that Internet stocks and other hot high-technology
issues are also ready to take a fall. But so far, such strategies have not quite paid off.
Tice, for example, has been short Yahoo! Inc. and Amazon.com Inc. at times and
often has had to swiftly cover his position when the market has moved against him.
Indeed, his market calls at midyear did not prove propitious (page 144). Lately,
however, he has profited with Inktomi Corp., a computer networking company that
went public at $18 last June and has been trading recently in the $120 to $130 range.
The stock has climbed as high as $158, and Tice expects it to fall further from what
he views as grossly unrealistic levels.
BIOTECH TARGETS. The spectacular performance of Internet auction house
eBay Inc. also has attracted shorts, who are betting against the stock because of its
stratospheric valuation. Tice hasn't shorted eBay but expects that, at a recent share
price of 230 times sales, he eventually will take a short position. Another noted short
placed a bet against eBay at about 170 and has seen it climb 20 points higher since
then. But this eBay-basher is unfazed, arguing that Internet stocks such as eBay are
''phenomenal shorts'' that will buckle if there is any economic weakness.
Wagering against stocks on the basis of valuation is a time-honored strategy--and
often a very bad one. It has fallen flat for stocks such as America Online Inc., which
has been shrugging off attacks from short-sellers for years. A sounder practice is to
short stocks of companies that are not just overvalued but also have some fundamental
weakness--a product, for example, that works far less well than investors may expect.
Some biotech stocks, such as Biotime Inc., have been targeted by shorts on that basis,
with varying results.
Shorts also look for companies with questionable accounting. Shorts took aim at
Computer Learning Centers a year ago for that reason. The company has vigorously
denied short-seller allegations, but questions surrounding its accounting have sent its
shares tumbling to nearly one-tenth of their prices of a year ago. Today, the leading
accounting-practices target of short-sellers is Sylvan Learning Centers, a
Baltimore-based educational services firm. Bear Stearns & Co. analyst David Nadel
has publicly questioned the quality of Sylvan's earnings, such as its restatement of
acquisition-related expenses. Sylvan management has emphatically stood by its
accounting methodology. Bear Stearns for a while withdrew, and then reissued, a
Nadel report on the company. Short-sellers share the analyst's misgivings--and then
some. One short who requested anonymity has shorted Sylvan stock in the view that
its shares will decline precipitously because of the kinds of concerns expressed by
Nadel.
HOW COLLECTIBLE? Short-sellers also find opportunities in small ''niche''
companies with unique--but not always all that magnificent--product lines. One such
stock that has begun to draw interest from short-sellers is Action Performance Cos., a
Phoenix corporation that designs, markets, and distributes licensed motorsports
collectibles. Shorts are questioning the growth prospects of this merchandise, in the
view that motorsports themselves are not growing wildly.
Another niche stock getting short-seller interest is AgriBioTech Inc., a Las
Vegas-based grass-seed company. The company put itself up for sale in October but
has yet to find any buyers. A recent Securities & Exchange Commission disclosure
showed that cash flow from operations has not been sufficient to meet its debt-service
obligations--without, that is, additional financing. Shorts are wagering on a continued,
unstemmed cash outpouring, one that they feel will send the stock crashing. Shorts
also are betting against such widely diverse small-cap companies as Iridium World
Communications Inc., a Bermuda-based global mobile wireless company, and 800
Travel Systems Inc., a travel agency that specializes in low-price plane tickets. Shorts
view both companies' prospects as wildly overstated by the market.
Wagering against small- and micro- cap stocks is just one way of making money on
the short side. Shorts can also wager against the overall market by buying puts on the
Standard & Poor's 500-stock index and on the Major Market Index. Another way to
go short is with ''Spiders,'' the S&P 500 unit trusts, and with the ''Diamond'' Dow
Jones industrial-average unit trusts--both traded on the American Stock Exchange.
One way to wager against the technology sector, if you expect a downturn there, is to
short semiconductor makers--notably Intel Corp. The Prudent Bear Fund's Tice is
expecting a slowdown in computer sales, which he feels will cut into sales for Intel
and other semiconductor manufacturers, such as Applied Materials and Novellus
Systems Inc.
Shorts are also wagering against selected financial companies, betting that they will
take it on the chin if the economy falters. One that has begun to garner interest from
shorts is AmeriCredit Corp., which securitizes car loans and originates mortgage
loans. The company has doubled from its 52-week low of 6 5/8 on Oct. 8. Tice is
shorting companies vulnerable from overly permissive lending practices, among them
private mortgage insurers such as PMI Group Inc. ''In an economic downturn, you're
going to see a substantial increase in defaults,'' notes Tice. He also is short large-cap
companies whose growth prospects are, he feels, on the wane--notably United
Technologies Corp. and Caterpillar Inc.
Despite the market's recent travails, short-selling remains an unpopular pastime on
Wall Street, and fund companies have not been rushing to organize short-selling
mutual funds along the lines of Tice's. Indeed, even with his recent good
performance, the bull market has sent his performance down 28% year to date.
Short-only hedge funds, meanwhile, were down 8.5% through the end of November,
according to figures compiled by Hennessee Group LLC. Discouraging figures. But
shorts prove time and again that some stocks are so weak that not even the hottest
market can save them. |
