Two Calculated Risks Possibly Worth Taking 31 comments
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Many people are thinking there will be an Obama rally in January, in part due to his popularity and in part due to the stimulus package that he and the Congress are proposing. Then too there are the recent actions of the Fed – both lowering interest rates and declaring that they will apply every means they can to bring the economy out of its downward spiral. There is the rescue of the Big 3, which seems likely to need more money. However, it also seems likely that those 3 will get it if they make a very strong effort toward profitability in the near future. This should actually be a very positive process, since the automakers should emerge from it much stronger than they were going in. Oil prices are down, which is terrifically good for the US economy. I could go on.
If you believe in the likelihood of this January rally, how best can you profit? I have noticed two stocks which seem to present excellent opportunities: LDK Solar (LDK) and Cypress Bioscience (CYPB). Why these two? They are both excellent short squeeze candidates. LDK has 11.3M shares shorted with a float of 32.8M (Mr. Peng still owns most of the shares, which actually speaks well of his faith in the company).
LDK is a solar maker. Since Obama is a noted “green” and alternate energy proponent, virtually all solar stocks should benefit as he is inaugurated. Further there is likely to be some stimulus for the solar industry built into the approx. $1 trillion stimulus package. This should benefit all solars, even foreign solars such as LDK. LDK has extensive long term contracts. LDK has already sold all of their 2009 production for fixed prices. If the recession worsens (as many expect), it is unlikely that LDK will have to sell any of their production for reduced prices. Rather, the price of raw polysilicon has been falling, so it is likely that LDK will be able to increase its margins as the year goes on.
Further LDK will have its own polysilicon plants coming online in 2009. The first stage of the big one is supposed to be functioning by the spring. This too should allow LDK to raise their margins. If you add LDK’s already fantastic numbers to this, you get a really pretty picture. LDK has a PE of 4.28, an FPE of 3.10, and a PEG of 0.09 (Yahoo finance). If the market starts to take off to the upside, LDK, with a Beta of 1.3, is sure to follow. When this happens, the short squeeze will kick in. The short sellers will have to cover their positions; LDK’s fundamentals are just too good not to. The short interest is about 35% of the float. It is supposed to take about 5 days to cover it. That should provide for quite a rally. Further the short interest has decreased about 10% in the last month without a substantial rally. This bodes well for LDK’s direction in the case of a good January Obama rally. Oil is also positioned to rally. An oil rally could be further spurred on by the infrastructure spending the Obama stimulus plan is now proposing. If this happens, it will add further fuel to the LDK rally.
CYPB is a new biotech company which has recently submitted a fibromyalgia drug, milnacipran, to the FDA for approval. CYPB submitted based on two phase 3 studies. Since that time, they have completed a 3rd phase 3 study, which lends further credence to their claims for the drug. CYPB is currently at $6.65 (Friday’s close). The analysts say that CYPB could go to $15 if the drug is approved. Analysts also say CYPB could go to $1 if the drug is denied approval. The current average analyst rating on this stock is 1.5 (a strong buy). Piper Jaffray recently initiated a Buy rating on the stock. Zacks recently recommended it highly. Generally people think that it is no longer a question of whether the drug will be approved, but when. The FDA is a little backed up at the moment. Plus they could ask for more proof.
However, the most likely data they would ask for would be the data supplied by the 3rd phase 3 study, which was very positive. It also seems unlikely the CYPB will go to $1. CYPB has considerable money on its balance sheet (about $168M in net tangible assets) in cash and short term investments. This equates to about $4.4/share. It has no debt.
In addition there are many years of positive data on milnacipran from outside the US. The actual timing of the approval of this drug seems somewhat up in the air. However, it could come in the relatively near future. A January rally should push this stock price up considerably. If this happens, most of the short sellers are likely to liquidate their positions because the technical data on the new drug is very good. If the approval comes during this rally, the stock could overshoot the analysts' target price of about $15. There are currently 4.9M shares shorted with a float of 37.6M. Since this is a lightly traded stock, it would take 10 days for the shorts to cover.
This would provide a huge boost to the stock price. This looks like a great buy at least until after the huge boost it gets from the drug approval. At that time you would have to reevaluate the stock based on its new price and its future prospects. The upside gain potential is about $15 - $6.65 = $8.35. The longer term possible (but not probable) downside move is likely limited by CYPB’s net tangible assets value of $4.4/share. The downside potential is thus $6.65 - $4.4 = $2.35. This makes the risk/reward ratio on this stock $2.35/$8.35 = 0.28.
In other words, to get a likely profit of $8.35 you are only risking $2.35. If you make enough of this kind of investment, you are extremely likely to come out a big winner.
Disclosure: Author holds a long position in LDK and CYPB
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This article has 31 comments:
this its my criteria for the January bounce of at least 50%.
CYPB is not my idea of a January bounce. It will move if approval by FDA.
Oversupply of polysilicon due to almost a dozen new entrants into the market is going to lead to a halving of solar cell prices. That, plus cyclical lack of demand due to both saturation in Europe and a collapse of new housing in the US bodes very poorly for any maker of solar cells - especially a new one.
How can LDK as a solar cell provider AND a polysilicon maker hope to have any type of decent earnings in this environment?
With overall overall solar market sales set to decline plus unit prices collapsing - sometimes a catastrophic stock price drop is deserved.
In addition to LDK, I think you could look at SunTech Power (STP) and Yingli Green Energy (YGE).
Good article - I enjoyed the thorough analysis.
Zach
zachstocks.com
I say in the short term, because as things heat up in the long term, poly prices will undoubtedly start to increase again, and this is where LDK's in-house poly production will make the difference. While everybody else is trying to do business in an environment of increasing poly prices, LDK will have their own supply at decreasing prices.
Also, you should know that LDK doesn't make cells, they make wafers, and their customers do the rest. As David mentioned, LDK is sold out for the year already, and many of their contracts are at a fixed price.
Oh, and as for the crashing housing market, it's true that the homebuilders aren't building right now, and they shouldn't be. The housing glut isn't to be solved by building more houses, but a heck of alot of those workers, and the housing industry as a whole, can benefit by moving to UPGRADE some of that existing housing, in the form of value added by Solar Installation / Energy Efficiency Technology.
Shortzqueeze is correct. Peng's shares are part of the float too, of course.. those 32 mill is the free float, but the entire float is 112+ mill shares.
LDK does not make solar cells, just wafers. One of their largest, if not their largest customer is SPWRA which makes the highest efficiency bifacial cells and is a power plant scale integrator also with a huge business in placing modules on warehouse and bib-box store rooftops.
The 'glut' of uninstalled modules will quickly be snapped-up by the large scale integrators - they are already pouncing! Some module makers are even buying competitors' products to meet commitments and to contract for more business.
LDK's 'rolling' pay-to-play contracts are gold: you have to take your order or loose your downpayment and your place in the queue for more.
In fact you pay full price on delivery and roll that downpayment for your next extension year.
I concur with the postive LDK analysis [hold stock and calls].
You have to look carefully at what the real float is. Just as many sites miss the fact the SOLF, for example, reports in RMB thus sites still give misleading PE ratios.
TD Ameritrade does not list shares in short interest, they simply give a % of the Float as 34.5% and Outstanding Shares as 106M. I don't know where you got your 32.8 M shares outstanding for LDK from. I have found TD Ameritrade to be in error before with this statistic (% short interest)
SchaeffersResearch.com & Shortsqueeze.com are in agreement with 112.9M outstanding and between 11 - 13 M shares short or around 11%. Shaeffersresearch.com only gives short shares data from 12/1 and shortsqueeze.com is more current 12/15. These statistics are relevant to your analysis if you think much of the Obama rally for LDK will be due to a Short Cover or Squeeze.
On Dec 28 12:58 PM David White wrote:
> searcher68: I think shortsqueeze.com is in error. TD Ameritrade shows
> only 32.8M shares in the float. This agrees more closely with my
> recollection that Mr. Peng still owns more than 60% of the stock
> in LDK (i.e. this stock is not traded and is thus not considered
> part of the float). It is possible this situation has changed without
> my knowing it. However, it seems more likely that someone at shortsqueeze.com just made a careless error.
If you go to the FORM 6-K filed with the SEC, dated 11/19/08 you will find that the 106M shares outstanding (TD Ameritrade) is for 6/30/08, and the 113M is for 9/30/08 quarterly filing. Short Interest is also being effected by $400M in 4.75%, Senior Convertible Notes that have been sold over the Summer Months and have Prospectus updates filed with the SEC, if interested. These notes would routinely have the buyers also short the underlying equity to hedge their investments. The notes also have a convertible price of roughly $39 / share at maturity.
The only other point that I would add is if LDK it truly going to Rally in January because of Obama's green infrastructure, you need to keep in mind that LDK is a China based vertical manufacturing operation, with its US based offices in California. Its shares here are ADS and its company registration is with the Caman Islands, not the US. It may not benefit from a US push to increase a manufacturing industry here in the US.
I really think people should be a little more dilligent in their search of information in TD Ameritrade before essentially calling someone else a liar. I have also copied a defintion of free-float from the Web below:
In the calculation of free-float, two types of shareholding are excluded; firstly shares held by interested parties and secondly long term, strategic shareholdings of a significant portion of the issued shares.
Interested parties:
Management and Board members: Shares owned by a company’s management or Board of Directors are not included in free-float. Similarly, shares owned by persons related to or affiliated with the company’s management or Board of Directors are not included in free-float.
Corporations: Shares held by a company itself as treasury shares (or in some equivalent form) are not included in free-float. Note that, as the Exchange does not currently include treasury shares in total market capitalization of the company, treasury shares are excluded from the base upon which the free-float is calculated. Please refer to the example below for further guidance.
Employee Share Ownership Plans (ESOPs): Shares held by a ESOT, even if not allocated to underlying beneficiaries, are not included in free-float.
Strategic shareholdings
Private or public shareholdings with investment objectives that indicate those holdings are not likely to be available to be traded in the market due to their long term investment horizon.
Individuals: Free-float generally includes shares owned by individuals not included in the definition of Management and Board Members above. However, significant shareholdings held by individuals that are strategic in nature should not be included in free-float. There is a rebuttable presumption that any holding of 5% or more in the capital of an issuer held by any individual and corporation, other than an institution acting for its clients, be considered a long term strategic holding.
Governments: Shares owned by governments and affiliated entities where the investment objective indicates that it is strategic should not be included in free-float (e.g. the Government’s 20% holding in Aer Lingus Plc).
Government agencies and government-related investment funds: The investment objective of the agency / fund will determine whether the shareholding is strategic and therefore not included in free-float.
Investment funds, mutual funds or unit trusts: Shares owned in investment funds, mutual funds and unit-trusts are included in free-float.
Pension funds: Generally, shares held by pension funds (including shares of a company for whose employees the fund has been established) are included in free-float unless there is a strong indication that the holding is strategic.
Venture capital funds: Shareholdings are included in free-float unless the investment is strategic in nature.
Banks / Lenders: Shareholdings by such entities are included in free-float if the investment is non-strategic in nature.
Nominees or trustees: Nominee or trustee registered shareholdings are classified as strategic or non-strategic based on an analysis of the beneficial owner of the shares.
Insurance companies: Shareholdings are included in free-float unless the investment is strategic in nature.
Lock-up periods: Shareholdings that are subject to lock-up periods are not considered to be free-float during the lock-up period. When the lock-up period expires, the shares are classified as free-float or non free-float based on the nature of the shareholder and is subject to standard free-float rules.
Others: Inclusion in free-float should be based on analysis of the strategic or non-strategic nature of the holding.
Shorts are squatting here and they need to be curtailed and made to pay up.
SEC?
Even if the stocks they follow has gone down 40,50, or 90% in a given year, they still come out with 5 star rankings with ridiculous target prices that are never adjusted downward!
If everyone would just wait for FDA approvals and then get in, at least they can watch their stock grow on Revenues with less risk.
Return on Equity, Qtly growth, little or no debt and substantial revenue eliminates much of the risk, compared to the hype, touting, and misinformation that is thrown in investors faces on a daily basis.
Investors should go back to basics and forget about services, T.V. personalities and analysts.
Who controls or sets the $ price of what the cell itself is made of?
How many cells per kilowatt-hours per dollar?
How much does the land that the cells are installed on lease for?
Is the kwh per $ enough to interest homeowners?
Is the kwh per $ enough to interest utilities?
Is the means for storage of solar energy during dark hours affordable?
Will bio-diesel, geothermal or wind blow solar away or is the demand adequate for all to exist?
Will technology invent yet another way to beat the proposed systems so far?
Your question about storing solar energy does not make any sense. Solar puts out the most energy when the demand is highest. It doesn't need storage. We won't have to worry much about energy storage with wind either, until renewables reach 15-20% of the grid. This is a bit of a red herring. Denmark is now starting to have storage issues with their 20% wind power. We are not even close to that, with solar accounting for something like 0.4% and wind a few percent of the energy grid.
Furthermore, storage is not the only solution to balancing the grid. If HVDC transmission is added to the grid, which is very likely, then transmission and a smart grid can do much of the balancing. Electricity is shunted around to match time zones, energy prices and demand, which differ all over the country and by time of day. We need both storage and new transmission to do the job.
Here's an excellent analysis of this storage/transmission mix.
www.altenergystocks.co...
Solar thermal comes with it's own energy storage at far less cost than storing electricity, and can generate even at night.
There is not going to be a problem of renewable energies competing with each other. Think 300 gigawatts of wind and a similar amount of solar by 2030, or about 20% of the grid for each.
And that's just the U.S. Think 2000 gigawatts of each globally.
Those are the kind of numbers we are shooting for to end our addiction to fossil fuels and stave off the worst of climate change.
Total coal generating capacity is 313 gWts supplying 50% of kilowatt hours. Total U.S. generating capacity is about 1025 gWts.
Solar thermal alone could replace all the coal plants by 2030 with base load dispatchable power.
Nanosolar says they can now build a solar system cheaper than building a coal plant. That means grid parity. And it needs no fuel or environmental cleanup of pollution and greenhouse gas. They are marketing their systems to small towns across America, where they suggest using land on the outskirts of town. 10 acres would power 1,000 homes, 20 acres 2,000 homes and so forth. You may not see this in heavily built up areas like the northeast, but it makes sense in the midwest and west where there is lots of space between towns.
First Solar is also close to grid parity. The rest of the solar industry is not that far behind.
Expect a national energy policy on a par with California. This will mean minimum targets for renewable energy as a percent of grid.
Creative financing policies like that inititated by the city of Berkeley
California will make it easier for homeowners and businesses to install solar. Berkeley will sell bonds to finance solar, which will be offered to every homeowner in the city with no upfront cost. Homeowners will pay off the solar on an annual basis, and be able to pass on any unpaid amount to the next owner if the house is sold.
Similar financing plans are being used to encourage large businesses to install solar.
With tax credits and rebates, payback time is 10-15 years. Within five years much of the country will have PV solar at grid parity.
Within 10 years all of the country will be there.
As far as new technologies, they will be welcome when they get here but are not necessary to make a big start in converting to clean energy.
The goals I mentioned for solar and wind can be achieved with current technology.
Nice pumps, fella. (Want to buy some GM?)
As for LDK, it does have debt. It has spent a lot to grow quickly. This is likely the primary reason it sells at a discount to many other solars. However, it has adequate cash, credit, and revenue stream to see it through the recession. If it needs more, the Chinese banks seem very likely to give it to LDK. It has an excellent plan. It has long term contracts at fixed prices, which should virtually guarantee its revenue stream for the next 2 years or more (it actually has contracts going out 5 years or more). It is cutting its costs (for example the polysilicon plant, which will expand its margins). Plus it is expanding rapidly. It should weather the current downturn much better than most other solars. This should leave it in a leading position in the industry. Even in the relative worst case in which wafer prices come down and stay down, LDK should be better off than most of the other solars. LDK will have expanded. It will have more clients. It will have higher margins. Even if it later loses margin due to long term decreases in solar wafer prices, it will have more margin with which to absorb these price decreases. All of these things should allow it to lead the industry going forward. It already has fantastic fundamental numbers. Once the polysilicon plant is complete, it should be able to manufacture for costs per watt comparable to FSLR (and perhaps the CIGS guys, especially with UMG solar technology). Yet LDK trades at almost an order of magnitude lower PE than FSLR. This makes it look like a bargain.
This article really only deals with the short term case of a possible rally if the market rallies in January. LDK has a Beta of 1.3. If the market rallies, it should rally faster. If it begins to rally, the short positions should seek to cover their positions. If there is an energy rally (possibly due to an improved economic outlook on account of the Obama stimulus package), this too should add to LDK's upside. The stock should push higher. I actually believe that this stock has good long term potential. However, this article is only meant to deal with the idea of a potential short squeeze situation in LDK if such a January rally occurs. I think I have made a good case for that. Perhaps you are short this stock too???? I was really unaware that GM had a PE of 4 like LDK or a PEG of 0.1. The lack of truthfulness in your comparison speaks for itself.
I'm glad that the author owns the two companies. I'm tired of articles recommending strategies that they don't buy into. Or, they'll have 10 analysts on TV each recommend their favorite stock, and nobody owns their favorite stock, but they might own it in their mutual fund.
Also, it looks like you do your homework. I'm adding you to my reading list.
I agree FSLR is too expensive. LDK's downside is that oil prices just fell a bunch(as with the rest of alternative energy). The upside is that the governments don't care and are going to be converting to solar and wind anyway. Obama loves the solar!
Also, the downside potential of any stock is $0. People will sell gold for $1/lb if you hide it in human waste. Short term you must believe that anything's possible.
I own 2010 Calls on YGE, LDK looks reasonable. I don't know enough to comment about CYPB.
Check out GEOY, they just launched a $500M satellite that is twice as good as anything up there and are market capped at half of that. They are already signed with Google and Microsoft.
Glen Bradford
Aren't we always looking for good new opportunities? My other two floating ideas that aren't resting on deep company analysis are the reversal of oil and the bust of treasuries.
When oil finally turns for good, and not some nifty shift like we had yesterday, I'll be buying DXO.
Also, when people start realizing that they're getting negative real returns on US treasuries and that they are making bad investment decisions (this is bound to happen), I'll be going long TBT (which is double short US 20+ year treasuries).
But, whatever you do --- don't get excited early on these trending ideas. You have people like Mark experiencing "the escalation of commitment"
seekingalpha.com/artic...
seekingalpha.com/artic...
On Dec 30 09:31 AM David White wrote:
> Glen Bradford: Thanks for the advice. I am always looking for good
> new opportunities.
I will look at DXO. Thank you for the advice.
The issue to my mind is can you trust their accounting? I hear chinese companies keep 3 sets of books - one for investors, the 2nd for the chinese govt and 3rd for the spouse.
CYPB is still going strong. It essentially done nothing but go up since I wrote this article. I am still hopeful that the drug will be approved soon. Then we may see it go to $15. None of the analysts seem to believe the drug will be dienied approval. The major question seem to be the approval date. The FDA's statements so far would seem to confirm that view. So far, so good.
Good luck if you are going to try to play a rumor upswing. After all was said and done today, LDK was up $0.15 for the day (about $15), after being down to approx. $12.50 overnight.