IRID mentioned in BusWeek article on stocks on shorts' hit lists
BUSINESSWEEK ONLINE : JUNE 14, 1999 ISSUE
COVER STORY
Can't See the Roses for the Thorns? Sell Short
This year, Net stocks are heading the shorts' hit lists
Short-sellers are cockeyed pessimists, always cheerily foreseeing all manner of
calamity. They merrily predict that earnings are about to fall off a cliff, that
investor sentiment is heading south, that lawsuits are in the works, and that, in
general, the stocks they are shorting are heading for bad times. Today, as
portrayed by the shorts, the stock market is a happy hunting ground of
overvalued stocks, particularly in the high-flying Internet sector. With their
soaring valuations and, usually, absence of profitability, E-commerce stocks are
at the top of short-seller hit lists nowadays.
Shorts sell borrowed stock in the hope of replacing it with cheaper shares and
pocketing the difference. This investment strategy is always risky--because
losses are theoretically unlimited--and is particularly chancy when applied to
Internet stocks. Such stocks are frequently driven upward by hype on Internet
message boards. When that happens, short-sellers can be subject to
''buy-ins''--in which brokers replace the borrowed stock, whether the shorts like
it or not.
Despite these risks, professional short-sellers are enthusiastically targeting
Internet brokers, notably Ameritrade Group, J.B. Oxford Holdings, and
E*Trade Group. These companies have outlandish price-earnings ratios: 207 for
Ameritrade, for example, based on estimated 1999 earnings. The rationale
behind shorting Internet brokers is simple--that they are priced by the market as
if they are Internet companies when they are really brokerage firms, which
usually have far lower p-e ratios. ''Just as you shouldn't value Bear, Stearns &
Co. as a telephone company because it takes orders over the telephone, you
shouldn't value Ameritrade as an Internet company because it takes orders over
the Internet,'' says one prominent short who requested anonymity, as did most of
the short-sellers interviewed for this article.
OVEREXTENDED. Moreover, short-sellers note, online brokers are widely
used by amateur investors to buy Internet stocks--often on margin. One short
seller contends that ''at the end of the day, what they do is loan money to people
they don't know.'' These investors will lose their shirts if the market sentiment for
Internet stocks, already on the wane, grows hostile--and Internet brokers will
find their business slipping away if that happens. Shorts assert that online
brokerage firms are insufficiently capitalized to withstand the credit risks that
they are taking on. Shorts also believe that online brokers will be hurt by
competition. The dangers here are from two areas. One is established
firms--such as Merrill Lynch, which is beginning its own low-fee online
operation--and the other is a slew of price-cutting outfits. Shorts believe that
barriers to entry are so low that competition from established brokers and
upstarts alike is likely to cream the Internet brokers, and have ripple effects on
companies doing business with them. One short is betting against Knight/Trimark
Group, which operates the Knight Securities market-making firm, because of its
large volume of business with the Internet brokers.
Other high-flying E-commerce companies similarly are attracting short-seller
interest. Bob Bandera, who runs the Westlake Investing investment boutique, is
shorting Navarre, which runs an Internet radio network that has excited a lot of
investors. The stock is down to 12 from its 52-week high of 27 last Nov. 30,
but Bandera feels that the prospects for the company, which has been losing
money, are vastly overestimated by the market. Bandera also is wary of the
runup in eToys, which went public on May 20 at $20 a share and quadrupled by
the end of the day. But he notes that shares of that company are almost
impossible to borrow. Once that changes, however, the shorts are likely to leap
in. ''The [market] valuation is close to Toys 'R' Us,'' Bandera observes.
Shorts believe that the unprofitability of E-commerce firms will eventually turn
these stocks into dogs. David Tice, who runs the predominantly short Prudent
Bear mutual fund, is shorting Amazon.com, despite its volatility, with the view
that its market capitalization is overvalued and that the company's profit potential
is limited. The online goliath, he asserts, is losing money despite its increase in
sales and ''increasing volume at increasing losses doesn't make sense,'' says
Tice.
Another theme followed by some shorts is to bet against stocks that are
vulnerable to weakness in the economy. Tice notes that Walt Disney, for
example, has enjoyed rising sales in its theme parks and hotels. But Disney stock
would be hard hit if negative economic tidings threaten to put a dent in the
family-vacation business.
BAD-NEWS BULLS. Bad economic tidings would also hurt another stock
that has drawn short-seller interest--Finet Holdings Corp. Finet offers online
products centering around real estate and mortgages, and its shares have soared
448% so far this year. Short-sellers are betting that low barriers to entry--the
bane of electronic commerce generally--and rising rates do not bode well for
this company. Microchip Technology, which makes specialty computer-memory
products, is being shorted in the belief that demand for its product line is not
likely to keep up, and that its soaring price--up 70% over the past year--is
vastly overblown.
One proven short-seller strategy is to short the stocks of companies that have
already been beaten down because of bad news of various kinds. Sometimes,
value-hunting investors buy these stocks in the view that ''all the bad news has
come out.'' But short-sellers, on the basis of their own research, sometimes
reach the opposite conclusion. One company being shorted for that reason is
Iridium World Communications, which owns and operates a global mobile
wireless communications system. The company has seen its price plummet in
recent weeks because of its admitted difficulty in repaying bank loans, and the
company has said that while it is seeking a restructuring of its debt, bankruptcy
cannot be ruled out. One major short-seller is betting that Iridium's troubles are
far from over and that the stock remains worth shorting even at its depressed
price--down 77% this year.
Previously announced bad news is the reason some shorts have targeted
Pediatrix Medical Group. The health-care company recently disclosed that it has
received inquiries from state investigators in Arizona, Colorado, and Florida
''related to its billing practices.'' Pediatrix Medical says it is cooperating with the
inquiries and ''believes that its billing practices were proper,'' but is unable to
predict whether they will have an adverse affect on the company's business. One
short is betting against the company because of these inquiries, in the view that
Pediatrix shares, down 62% so far this year, have further to fall.
Betting on declines in the overall market, formerly possible only with index
futures, has become more practical even for small investors in recent years.
Investors can also short the overall market by short-selling index-lin cked
depository receipts. These include the SPDRs, or ''spiders,'' that mirror the
Standard & Poor's 500-stock index, and other shares that mirror the Dow
Jones industrial average and various S&P indexes. Unlike similarly structured
mutual funds, these can be sold short.
But ''fighting the tape'' by betting against the raging bull market has been a losing
strategy for a long time. Better to pick and choose the dogs of the market. They
can be miserable to own. But for short-sellers, misery is a wonderful thing.
BY GARY WEISS |
