Take Advantage of the Market's Pop and short these 3 stocks
With the overall market, and particularly momentum names rebounding strongly over the past month, I thought now would be a good time to take a look at some short-sale opportunities. Fortunately, one need not look to hard to find a myriad of massively overvalued companies. I estimate that each of the companies mentioned below has over 60% downside. Here are the key criteria for these short sale candidates:
- Market capitalization greater than $4 billion
- Trade at greater than 8x trailing revenue
- Limited history of profitability - failure to demonstrate a successful business model
- Highly promotional CEOs who have sold tens of millions worth of stock
Athena Healthcare (NASDAQ:ATHN) has rebounded almost 30% from it
s recent low after David Einhorn panned the stock during May's Ira Sohn Conference. Athena now trades at over 6x forward revenue and 100x earnings (and 97x 2015 earnings). While the company has grown revenue at a rapid clip over the past couple of years, revenue growth is slowing dramatically (expected to be <24% in 2014). In order to continue to grow revenue at a high rate, Athena will have to successfully enter new markets - markets which are rife with well-funded competitors. Beyond having revenue growth challenges, like many of today's high-flying software companies, while Athena has shown an ability to attract customers, it has yet to prove that it is a business which can actually earn profits for its shareholders. Athena has an operating profit margin of less than 5% and has not been able to demonstrate that higher revenues will lead to higher operating margins - in fact, the opposite has occurred - as revenues have grown, operating margins have declined from 10% in 2011 to just over 4% last year. This is yet another red flag. When the market comes to its senses, I think Athena will eventually be valued at around 1-2x 2014 estimated revenue. Factoring the company's net cash balance, this gets me to an intrinsic value of $20-40 which is 70-80% below today's price.
ServiceNow (NYSE:NOW) has rebounded strongly (+23%) from its recent lows and now trades at over 14x forward revenue despite being on track to lose well over $100 million during 2014. While Now's highly promotional management team (which has presented at ten investor conferences in the past 11 months and sold hundreds of millions worth of stock over the past couple years) takes every opportunity it can to point out new market opportunities (like HR), the reality is that virtually all of NOW's revenue comes from the ITSM (Information technology service management) business which has an estimated market size of ~$2-$2.5 billion (of which 50-70% is likely to ultimately be served by SAAS providers). By showing such rapid revenue growth NOW management appears to have convinced many investors that the market is up to 10x the size of the ITSM market. However, with an unlimited budget (funded by buyers of shares/convertible debt), I believe that NOW has simply accelerated its penetration of the ITSM market. An unlimited sales budget essentially allows the company to accelerate notoriously lengthy sales-cycles as well as targeting companies across the globe. If NOW is truly limited to the ITSM market, its sales growth rate is likely to significantly decelerate - likely sooner rather than later (2015?). When this happens, things will get ugly fast. Should investors start to perceive NOW as a company with a large share of a small market (earning no profit), shares could fall meaningfully. Assuming 2015 revenue of $800 million and P/Sales of 3-4x (reflecting a slowing growth outlook), NOW shares could fall as much 70% (to $16-20/share). Should the market start to question whether SAAS companies will ever generate acceptable margins, shares could fall even further (my fair value estimate is only $15). Despite what management says, a quick look at their actions (such as massive insider selling) indicates that management agrees with me.
Zillow (NASDAQ:Z) has soared 21% from my last article where I highlighted several (six to be exact) reasons to short the stock. Fundamentally, nothing has changed- Zillow's first quarter earnings report showed that while revenue is increasing, operating expenses are increasing at a faster rate (and thus losses are increasing). At some point shareholders will start to wonder why Zillow generates losses- last month, UK real estate web site Zoopla announced plans to go public. Like its competitor Rightmove (OTC:RTMVF), Zoopla earns over 50% operating margins. Zoopla is just 6 years old (versus nearly 9 years for Zillow). Again, this brings into question why, if Zillow is such a disruptive, dominant company, can't it earn a profit? I continue to believe that Zillow disrupts nothing. It is merely another real estate lead generation website which creates little value for its customers (which accounts for a churn rate I presume to be very high -perhaps I'm wrong - I look forward to Zillow someday providing this information to investors). With a business that is fundamentally flawed, a highly promotional management team that sells shares literally every chance they get (CEO and CFO own less than 1,000 shares each), and a valuation which orbits the stratosphere (currently 14x forward revenue) Zillow has the main ingredients of a great short. While we lack an imminent catalyst (and this is a crowded short to be sure), at $125/share Zillow is an even better short today than it was 6 weeks ago. I continue to think that Zillow's fair value is somewhere around $20 (20x 2015 earnings), offering investors the opportunity to short something with 84% downside.
While management and sell-side brokers are working hard to convince you that these companies are the next big thing, it is important to consider their incentives and actions. Investment banks (who employ sell-side brokers - despite what they say, their 'independence of thought' is highly questionable) are dependent on IPOs, convertible debt issuances, secondary share sales, and inflated M&A deals to earn fees. Likewise management of these companies have made tens (in some cases hundreds) of millions by selling stock to the public. As such, investor's must look hard at the facts rather than rhetoric when making investment decisions. Caveat emptor.
Disclosure: The author is short ATHN, NOW, Z. The author wrote this article themselves, and it expresses their own opinions. The author is not receiving compensation for it (other than from Seeking Alpha). The author has no business relationship with any company whose stock is mentioned in this article.