by David Sterman
Short sellers must always stay on their toes. Any time the market is in rally mode -- as it has been the last few months -- they need to unwind their short bets, lest the rising market inflict untold pain. They tend to typically pile back into these closed short positions once they think a rally has begun to end. So it pays to take a fresh look at some of the most heavily-shorted stocks, if you believe that the recent rally has grown tired. Renewed short selling in these names could quickly push them back down.
Looking at the most recently available data, I found three heavily-shorted stocks that could be ripe for a fall.
Sprint (NYSE: S)
Simply looking at the recent quarterly results from this mobile telecom service provider, you'd probably think its shares are fairly valued with perhaps a bit of upside. But short sellers see an albatross around this company's neck that threatens to damage its balance sheet or sharply inflate its share count. And either of those events could push the stock, from a current $4, closer to the $3 mark.
Sprint has been heavily investing in an ultra-fast wireless technology through its 54% ownership of Clearwire (Nasdaq: CLWR). Even as Sprint has poured several billion dollars into Clearwire over the years, that might not be enough, as Clearwire just announced that money is quickly running out. That's a risk I highlighted in my negative profile of Clearwire back in August.
It may be hard to find any new investors as Clearwire seeks fresh capital (perhaps up to $3 billion). So to keep it afloat, Sprint may be on the hook to write another large check to partially aid in the capital rescue efforts. Sprint has ample cash, but also has its own debts to think about. The carrier will need to pay off a $1.6 billion bond in January, and has an additional $18 billion in long-term debt to worry about as well.
Short sellers are betting that Sprint will look to issue fresh equity or take on more debt to raise cash for Clearwire, and the potential dilution or increased balance sheet risk would likely put a hurt on Sprint's shares. However, this is a finite short play. Keep an eye on how Clearwire resolves its financing mess. If it can do so -- with or without Sprint's help -- and Sprint's shares hold their own, then it's likely time to cover the short position.
The St. Joe Company (NYSE: JOE)
This stock was a long-time favorite of value players, as its massive stake of undeveloped real estate in Northwest Florida was a potential gold mine. Many assumed that developers would pay top dollar to create a new Martha's Vineyard in a region known as the "Redneck Riviera."
Well, St. Joe sat and sat on much of that land, until the Florida housing bubble burst. Now, short sellers think the company's land holdings need to be written down to reflect their current value, and they suspect it will be a very long time before St. Joe will be able to realize any high value for its land. In the mean time, the company is slowly selling off land just to cover operating expenses and may not have nearly as attractive a real estate portfolio down the road if the Florida economy takes a long time to recover.
Yet it's the expectation of the need for write-downs that is the real near-term threat. Short sellers have been piling on to this notion, ever since it was proffered by fund manager David Einhorn at last month's Value Investing Congress. If St. Joe does feel compelled to write down the value of its assets (with some forecasters predicting a -25% haircut), then shares would surely take a hit. So this is a pretty clear short play.
Keep an eye on management's decision. If and when it decides to write down assets, you'd probably want to close out positions. If management doesn't do so by the end of the first quarter, it probably never will. Then again, there's not a lot of risk sitting on this short position, as few positive catalysts exist in the next six months.
Longer term, I tend to disagree with Mr. Einhorn. Florida is on its heels right now, but as I brace for another tough New York state winter, I dream of an eventual stake in Florida, as thousands of other northerners likely do. Down the road, Florida will once again become the real estate development capital of the country, and once the state starts to get back on its feet, St. Joe may be a solid play for longs.
Barnes & Noble (NYSE: BKS)
The bearish bets just keep on rising at the nation's largest bookseller. Shorts boosted their stake in Barnes & Noble roughly +5% in the last two weeks of October to 11.1 million shares, and it would take the equivalent of 29 trading sessions to unwind the bearish positions, the sixth-largest "days to cover" ratio of all publicly-traded companies. [I laid out the bear case against Barnes & Noble back in August.]
Since then, it has become increasingly clear that e-books are starting to take away market share from traditional paper-based books. And the e-books biz increasingly looks to be dominated by Amazon.com (Nasdaq: AMZN) and Apple (Nasdaq: AAPL), not Barnes & Noble.
Since my last look at Barnes & Noble in August, analysts have subsequently altered their fiscal (April) 2012 outlook from a small profit to a small loss. And since then, no other suitors have emerged for the company, even as it is considered to be "in play." Netflix (Nasdaq: NFLX) has Blockbuster (OTC: BLOAQ.PK) on the ropes, and rivals look similarly ready to make life just as bad for Barnes & Noble. That's why shares look so ripe to short sellers.
These three companies are in short sellers' crosshairs, yet each has a specific investment thesis in place. Investors need to stick to that thesis if they choose to short these stocks. If Sprint is able to ride out the Clearwire mess, if St. Joe's indeed writes down its real estate without taking a big hit, and if Barnes & Noble somehow funds a buyer, you'd do well to cover your short positions straight away.
Disclosure: Neither David Sterman nor StreetAuthority, LLC hold positions in any securities mentioned in this article.