I've been long Uni-Pixel (NASDAQ:UNXL) for several months, but believe that the time and price have come to switch out of the stock and into options, whether you are bullish or bearish. Both the investment philosophy and the mathematics behind this switch are simple, and I'll walk you through them. If you disagree with any of my estimates, just substitute your own and see where the calculations come out; I still think you'll find that options are the way to play this unusual opportunity.
My thesis is informed by my acceptance of the premise that if UNXL is substantially unable to execute, its stock will collapse to almost nothing, perhaps down to about three bucks a share. The current book value per share is $1.46 (of which $1.30 is cash), but I've doubled that to give value to the company's large intellectual property portfolio. If UniBoss and Diamond Guard, the company's only valuable products, cannot be readily produced in commercial scale - which is the heart of the short thesis and thus should not lightly be dismissed - the company would have no enterprise value. This is not to say that I believe the shorts are right, but they constitute about 44% of the stock's float, and they are not naïve or stupid people. They may turn out to be misguided or misinformed, but until the Fat Lady sings, it would be a mistake to totally tune them out.
If the company does not, during this week or next, as promised, prove the existence of a high-profile EcoSystem Partner willing to pay millions to promote its product, and if the company does not announce in this quarter the identity of the "world-class manufacturer" who has agreed to enter a JV with Uni-Pixel, the company will lose credibility and the pps will certainly fall sharply. Far more dangerous, if UNXL's plating lines are unable to execute as it has promised, the stock will plunge. If it can't turn out the UniBoss film in large quantities, roll to roll, at a rapid pace, without serious flaws and imperfections - the company has stated it will be producing at the rate of more than 45,000 sq ft a month by the end of June, 700,000 sq ft a month by end September, and more than one million in December -- and deliver them in a timely manner at the price points it has announced, the stock will implode down toward book value. A crucial test will take place this month, when UNXL has declared it would make the first shipment of product to the major manufacturer of personal computers whom it claims has entered into a preferred price and capacity license. Note carefully that I do not predict that these failures will occur, merely that they are possible and would be highly, perhaps terminally, harmful to UNXL.
This possibility makes UNXL a unique investing situation. It is not like a typical company which, should it fail to deliver on one of its numerous products, or sign up a certain customer, or hit a benchmark, or show a strong year-over-year earnings growth, is likely to drop ten or twenty percent. The situation with UNXL is close to an all-or-nothing one and, as such, I liken it to a lottery ticket where you are playing for high stakes and either win big or you lose the cost of your ticket.
If the stock could crumble to about 3 from its present price of 27, it would lose 24 dollars a share, or 89% of its value.
Let's now balance that against what those long shareholders might gain. If Uni-Pixel soon issues impressive customer and partnership announcements that can be verified, and which are supported by seven- or eight-figure cash payments to it, and if the company, during this second quarter, performs on all cylinders and delivers as promised, the share price will surely zoom up. I estimate that the immediate gap up on the merits would be to 50, and I'll conservatively add ten dollars more as the shorts rush to cover and a squeeze materializes. (That squeeze may not be as wild or severe as a lot of longs had counted on because it appears that many savvy shorts have limited their maximum exposure by purchasing hedging calls in the 40-50 area.) In addition to this quick rise to 60, which would increase share value by 33 dollars, the stock is likely to continue to appreciate throughout the year as management ramps up production and sells their touch screens. If they hit their target of one million square feet of screen per month by the end of the year with no falloff in margins, which I have seen variously estimated at between 65 and 80%, and applying even a conservative PE, the stock could easily be around 150 by Christmas, i.e. an additional 90 points above 60.
The most explicit and well-reasoned valuation analysis I've seen is contained in the detailed table, which utilizes twelve variables and four different sales projections, prepared and presented by economist Chris Hofmann is his article on this site on March 4, which calculates that EPS by the middle of 2014 would be somewhere between $7.85 and $26.98, to which he applied PE multiples ranging from a conservative 15 to a heady 40 to arrive at prices per share ranging from 115 to 1079 - not a typo! All within 18 months! It would not even be unreasonable to accord the stock a PE of 80, similar to what VMware (NYSE:VMW) boasted a year ago, yet still far below the 172 PE based on estimated 2013 earnings now sported by Amazon.com (NASDAQ:AMZN), because UNXL could, like them, own a game-changing franchise, giving it a per share price of over two thousand dollars!! All this is within reason if one accepts the industry projections that the touch-module market will grow exponentially to 32 billion dollars by 2018.
But for the purposes of this discussion, I will stick with a valuation of $150 by Christmas, close to the low side of Hoffman's computations, and somewhat more conservative than the valuation of $200-$265 a share within 12 to 18 months posited in the excellent article on this site on March 21 by Green River Assets. Just understand that my point applies even more strongly at the higher valuations, but those returns would be so astronomical that they might impart a sense of unreality into the discussion. .
WHAT ARE THE ODDS?
At this juncture we must introduce the odds, the probability factor, the risk, whatever you want to call it. Trial attorneys like me (now retired) use a simple concept called litigation-risk analysis in which we estimate the probable amount a jury would award in a trial and multiply that by a percentage estimate of the likelihood we think our side will win. We use the resulting amount as a guide in our negotiations to reach a settlement, as does the other side, although from the opposite perspective and with different estimates, and this kind of analysis could be helpful in this battle.
To determine the likelihood that UNXL will be able to deliver on time, in quantity, with good quality, and at the projected price point, one needs to consider a host of factors. (I am going to assume - although some shorts are sure to disagree - that UniBoss can, in theory, and when properly manufactured, perform as well as, and offer all the competitive advantages vis a vis ITO screens, touted by management. I will add that management seems to believe they will succeed, and has so predicted on several recent occasions, but those who don't trust management will dismiss that out of hand and change the odds accordingly.). We must also add that some smart companies like Texas Instruments, N-Trig, Carestream Tollcoating, and some sensor-controller manufacturers have already agreed to work with UNXL, as have (if you believe management) that major OEM (rumored to be Dell) and that Eco System partner (rumored to be Intel). As part of those as-yet-not-fully-disclosed agreements, we can reasonably assume that engineers and experts for the partnering parties have crawled all over the Uni-Pixel plant and carefully examined whatever samples were produced, and concluded that UniBoss/Diamond Guard can be manufactured for them in the quantities and to the specifications they require. Although slightly counter-intuitive to turn a seeming negative into a circumstantial positive, one might reasonably argue that the large intellectual-property lawsuit commenced against UNXL by Carclo in the UK is a sign that Carclo believes that UNXL will succeed and is worried about it..
Against this one must set the litany of complaints and allegations on which the shorts base their stance. These include, but are not limited to, the failure of UNXL to execute with two products in the recent past (a Time-Multiplexed Optical Shutter and Fingerprint-Resistant Film); the promotional character of management (I think the shorts favorite phrase is "snake-oil salesmen"); the opaque nature of the company's operations; the cloudy reputation of the company handling their investment banking; the immense difficulty of producing defect-free copper lines only six microns thick; the absence of any commercial-scale production to date; the alleged lack of clarity of the UniBoss screens; the impending competition from Atmel (ATML, a licensee of Carclo) and other metal-mesh manufacturers; the belief that product prices will fall sharply over time; the contention that the assumptions of UNXL management are overly optimistic, and have been so for many years; the delay in scaling up Diamond Guard; and, using a shameless bit of boot-strapping, the existence of their own very large short position as evidence of market incredulity.
Putting this all together, I estimate - and do not hesitate to substitute your own estimate since you have available the same public facts that I do - that the odds of a complete success in achieving all production, sales, and shipping goals that CEO Reed Killion stated in his conference call of February 26 would occur within this second quarter, are about one in two, or 50%. If this were a Powerball ticket and I were informed that I had one chance in two to win 123 dollars (the difference between 150 and 27), and one chance in two that I would lose just about all my money, I should logically - human psychology aside - be willing to pay up to 76 dollars for that ticket, i.e $76 for the stock. This would give you a upside of 74 against a downside of 73, about half the odds that favor the house if one plays red or black at roulette. .
If you take a perspective limited to the next two months, and assume that my gap-up estimate of 60 is correct for that time frame, the mid-point between the upside of 60 and the bottom of 3 is $31.50. Applying litigation-risk theory, and assuming the chances of success are 50-50, the analysis dictates that a long is in favorable risk-reward territory as long as he does not bid or hold above $31.50 which, interestingly, and perhaps not coincidentally, seems to represent a strong ceiling above which the stock has been unable to remain for more than a short time in the absence of hard news. At the present price of $27, the risk-reward ratio is 24 to 33 in favor of the long position, if the investor is only interested in a two-month time horizon. (If you don't accept my 50-50 estimate, then apply your own. If, for example, you think the odds are 70-30 in favor of success, then multiply the potential upside jump by .7 and the potential downside drop by .3 and the risk-reward ratio shifts to a more attractive 7.2 to 23.1.)
But even with those odds, a long can get a much better potential payout by buying options.
WHY UNXL CALLS ARE PREFERABLE TO THE STOCK
The main reason cited by investors for avoiding options is that, if the stock does not reach the strike price by the expiration date, they lose their entire investment. But we may already be in that boat because, as posited, Uni-Pixel could easily become worthless, making it very much like a lottery ticket, and thus mitigating the usual caution against buying options. The options may prove to be less risky, and far more profitable, than buying or holding the stock at these prices.
Furthermore, UNXL may be a once-in-a-decade ideal option situation because it is one of the most volatile stocks in the market, one day two weeks ago wining top ranking for the biggest percentage gainer of any stock and one day last week turning around and garnering the dubious distinction of being the second-biggest percentage loser in the entire market. It is a stock that could as easily go to the sky as into the crapper, and that is perfect for options. The company also faces some make-or-break events within the next month or two, so you don't have to wait long for a resolution and don't need to buy the more expensive calls that are many months out. (The slight drawback here is that the options market makers are well aware of the situation and thus slap on higher premiums and wider bid-ask spreads than any comparable options because they know the traffic will bear it in view of the huge potential profits. But, hey, what's a seller's extra take of 10% or so if you might make 20 times your investment?)
If you buy the July 40 call, for example, it will cost you about $2.50 at Friday's closing price. (I am not recommending the May call even though it is about a dollar cheaper because the Fat Lady may still be gargling.) By July, if the company had demonstrated the ability to produce and ramp up successfully, the stock could be close to 80, or 40 dollars in the money, a payout of 16 to 1 compared to the appreciation in the stock of 2 to 1. Buy the July 50 calls at $1.30 and that payout potential at a pps of 80 (i.e. 30 points in the money) is 23 to 1.
If you buy the December 50 call, for which $3.20 was the midpoint between the bid and asked on Friday's close, and if you accept my estimate that the stock could be 150 when Santa Clause is coming to town, or 100 dollars in the money, you stand to win 31 to 1, and a January 40 call priced at $5 would yield 22 to 1, compared to having been long the stock at 26 and realized a gain of 4.76 to 1. If you want to try for a long-term capital gain, you could buy the January 2015 call at 40 for $8.80 and, assuming the company is executing perfectly and the stock is around 200 dollars a share by the expiration date 20 months from now, you would get almost 20 to 1 and keep about twice as much after taxes. (If, though it seems almost inconceivably mind-boggling today, the stock is at the high end of Chris Hoffman's table, at one thousand dollars a share, your gain would be $110 to 1, while the stock would have returned only - some only, huh? -- 39 to 1.)
Full disclosure: After pondering the math and the odds, I sold all my UNXL stock on Friday and most of my July 20 calls and rolled the funds into January 2014 and January 2015 calls at a strike price of 40. I did this for four reasons, some of which may not be applicable, or of interest, to all investors. 1) For tax reasons I did not want to take any more large capital gains this year, so I pushed them off until 2014. 2) By going out to 2015 I convert the gains on those calls to long-term. 3) If UNXL needs an extra few months to execute, I don't want to be on the short end of the expiration date. And, most important, 4) I believe it will take some time for the market to fully perceive and understand UNXL as the tremendous investment opportunity I think it might be. There have been so many negative articles, so much short selling, so many brokerage firms listing it as a top short, and so much bashing of its patents, ethics, management, ability to execute, and ultimate potential, that it may take some time for the company to shake off the tar and feathers and really shine in the eyes of the investment community and move its stock price well into the triple digits. (I endured a similar situation for many frustrating years with Celgene, whose stock price languished below one dollar [adjusted for later stock splits] for its first eight years, and then rarely rose above ten dollars from 1998 until 2003, when the investment community finally began to understand its full potential and have since driven the price up over $115, although it is still underpriced for a stock that will earn $12 a share in 2017, but that's another story.)
THE LOYALTY OF THE LONGS
Before examining the short side, let me say this to the loyal and devoted longs: Do not be overly concerned that you would, by selling your stock and buying calls, aid the shorts to avoid a squeeze by enabling them to pick up your stock and cover with it. You should realize that, any upside pressure from a squeeze, even at these extreme levels of 44% short, eventually leaks out of the stock over time as more fundamental factors like sales, earnings, market expansion, and growth come to determine value, so if you truly believe in UNXL and its technology and potential, you should want to be in this for the long haul and rise this rocket into the stratosphere. If you instead concentrate on creating a near-term short squeeze through diligent stock retention you may win a very profitable battle but miss out on an immensely lucrative war. The key to amassing real riches in the market is not through day-trading or short-term tactics, but to find a genuine winner and ride it all the way home. Relying on this likelihood, I have only hesitated a bit before writing this article, even though I know it would probably negatively impact the stock and thus devalue my large call position over the short term. Eventually, if you believe in an efficient market, the stock and the calls should bounce back to where they belong. Moreover, I honestly believe that the purpose of writing an article like this should be to educate investors, or at least give them some valid food for thought, and not to try, as some do, to move the market in a direction favorable to the author's personal position.).
WHY UNXL PUTS ARE PREFERABLE TO BEING SHORT
By a logic similar to that set forth above for the longs, but with less compelling numbers, it does not make sense to be short the stock when you could buy puts. Although those who are bearish on UNXL are in a much better mathematical position to go short here at 27 than they were when the stock was at 10, it is still needlessly risky. When the stock was 10 the shorts might expect a win of 7 bucks if it collapsed to 3, but the potential stock appreciation was up to $60, which was a $50 risk for a $7 gain. Today the risk-reward ratio for going short is more favorable. Based on a potential gap up to 60 in the next month, the risk is 33 points against a potential gain of about 24 if the stock drops all the way to 3, but, at 50-50 probability, still a risk not worth taking.
If you went short at 10 or 15 or 20 and are now in the hole, my point is still the same, as is the math, although I understand the psychology is different, making it far harder to close out the position. Try to get over it. Just acknowledge that you made a costly mistake and cover because you are, if you accept my suppositions, facing 50-50 odds that you stand to lose more than you can possibly gain ($33 vs. $24) within a month or so. Get out, cover, take your loss, and, if you still believe in the short side, buy some puts.
There is no need to pay a lot and go out for a long term for puts. If the company is not able to deliver, that should be apparent by mid-May.
If you accept my estimate that a total failure by the company to deliver will drive the stock down to around 3, then perhaps buy the May 30 put for $7.70, or the May 20 for $2.40, or the May 15 for $1, and you could anticipate payoffs of, respectively, 3.5 to 1, 7 to 1, and 12 to 1, all of them far better than you could possibly earn by staying short. Most important of all, you limit your exposure to the price of the put, whereas in the present circumstances there is no clearly foreseeable cap to your risk. Almost as important - and I am truly not being snide or propagandizing here because I would offer this same reasoning to my close friends - you relieve yourself of a hell of a lot of pressure and, by getting out before the upcoming binary event, you avoid what could be a horrendous short squeeze.)
One other observation on the use of puts and calls, although it is surely so intuitively obvious to regular readers of Seeking Alpha that I have not mentioned it: If you really believe in your stance, whether bullish or bearish, and are willing to put your money where your mouth is, then not only do puts or calls give you far more leverage, but with the same amount of money you have in the stock or short the stock, you can control many more shares through the options, thus vastly increasing your payoff if things go your way. As one simple example, if you are now long one thousand shares of UNXL, that is an exposure of $24,000, assuming the stock can drop to 3 from 27. If you sell the stock for $27,000, take out $3,000 for a Caribbean vacation, and take that same $24,000 for which you were exposed, you can buy 100 July 40 calls at $2.40 and control ten thousand shares of stock, ten times more than you did before. And if the stock does gap to 60 by July, you are 20 points in the money, which is $200,000, whereas you would have made only $33,000 if you retained the thousand shares of stock.
Of course you can also easily lose all your money on the calls, so this investment posture makes the most sense if you accept the likelihood that you can also lose all, or almost all, your money on the stock if the company woefully fails to perform. If you do not accept that, then my entire Powerball/lottery analogy falls flat and you should stick with stock.
There are also some other scenarios where you would be better off to own or be short the stock than to have options. These would mostly be attractive to those whose sentiments range from buy to hold to sell but who are not true believers in the zealous long or fanatic short position. These are the situations where the shares would behave more like a normal equity than a lottery ticket. Once the total-collapse and the grand-slam-home-run scenarios are off the table, the case for stock ownership becomes stronger than the case for options.
For example, if the UNXL plating process does work, but takes a lot longer to ramp up, then the stock may not reach those 40- and 50-dollar strike prices before your calls expire. Or if the company performs in a lackluster manner, suffers a lot of growing pains, can't ramp up smoothly, and encounters a few quality-control issues, all of which harm its partnership relations, delay profitability, and allow competitors to slip in, but still hold out some hope of a bright future after these problems are solved many months later than predicted by management, the stock may neither zoom nor collapse, but retain some good portion of its value. In that case, whether long or short, you might be better off sticking with the stock and avoiding the options..
I've suggested herein a rough methodology for evaluating some very simple option strategies, but it's your call, so to speak. Good luck.
Disclosure: As mentioned in my article (and for the reasons stated in my article), I sold all my UNXL stock on Friday and most of my July 20 calls and rolled the funds into January 2014 and January 2015 calls at a strike price of 40. I wrote this article myself, and it expresses my own opinions. I am not receiving compensation for it (other than from Seeking Alpha). I have no business relationship with any company whose stock is mentioned in this article.