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During the course of the summer, players in the LED market started to become very concerned about the prospect for a significant slowdown in the industry, particularly as a result of a sharp slowdown in final demand for flat-screen LCD TVs. This sentiment hit stocks in the sector generally with, for example, Rubicon (NASDAQ:RBCN) selling off from its highs of 34.76 on July 26th to its low of 18.84 on October 12th, a decline of some 45%. Rubicon is, of course, a leading producer of sapphire substrate for LED manufacturers.

The day before its November 4th earnings announcement (see earnings report here) the stock had climbed its way back to 24.39 as the market awaited further evidence of the truth of the slowdown story. In the end, Rubicon surprised on the upside, continuing to post strong earnings growth. However, most importantly, Rubicon raised its forward guidance for Q4 from a previous 47 cents a share to 49 cents a share. That compared with market expectations of a lowly 37 cents a share.

Evidence of the slowdown story has not followed through. Despite this, Rubicon sold off heavily after the numbers and now trades just above the $20 mark. Part of this has been the weak performance of the overall market – but clearly something else is out of kilter.

Shorts obviously continue to look beyond the numbers to the predicted coming slowdown. However, the interesting part of the story is the size of the short base. The table below provides the numbers for short interest in Rubicon provided by the Nasdaq. The latest numbers are for the end of October. Since they are published every two weeks, we should have an update soon. However, the price action following the earnings announcement suggests that short interest may have grown further.

Settlement Date

Short Interest

Avg Daily Share Volume

Days To Cover

10/29/2010

10,433,833

707,367

14.750240

10/15/2010

10,474,595

1,036,819

10.102626

9/30/2010

10,020,979

1,181,445

8.481968

9/15/2010

9,404,172

931,735

10.093183

8/31/2010

8,921,944

561,375

15.893020

8/13/2010

8,157,005

940,682

8.671374

7/30/2010

7,157,866

709,188

10.093044

7/15/2010

6,665,699

440,018

15.148696

6/30/2010

5,899,910

923,249

6.390378

6/15/2010

5,657,050

571,577

9.897267

5/28/2010

5,389,454

248,675

21.672681

5/14/2010

5,215,642

505,419

10.319442

4/30/2010

4,883,926

496,191

9.842835

4/15/2010

4,965,864

317,533

15.638891

3/31/2010

4,873,054

295,867

16.470421

3/15/2010

4,597,194

237,010

19.396625

2/26/2010

4,413,401

143,720

30.708329

2/12/2010

4,170,823

283,062

14.734662

1/29/2010

3,983,769

258,386

15.417898

1/15/2010

4,008,131

173,859

23.053917

12/31/2009

4,127,232

415,089

9.943005

12/15/2009

4,150,001

250,333

16.577922

11/30/2009

4,361,912

150,250

29.031028

11/13/2009

4,142,857

263,066

15.748356

As the table shows, by the end of last month, short interest had reached 10.4 million shares and a hefty 14.75 days of cover. Focusing on days of cover is useful when comparing the data between stocks but can be misleading as the volume numbers move around – and are not necessarily a consistent indicator of liquidity, ie when the action starts volumes and liquidity can rise sharply – or otherwise.

What is striking is that in outright terms, the short interest in Rubicon has now grown inexorably over the past year, as the table above shows – from 4 million shares a year ago progressively to the most recent level of 10.4 million. This takes it to a full 61% of the float. Feeling claustrophobic anyone?

It is true that short positions in the stock market in general rose over October, particularly in Semiconductor Equipment, though not in the Semiconductor sector. To put Rubicon’s short position into perspective, the table below compares it with two related players – VECO and CREE.

Millions of Shares

RBCN

CREE

VECO

Short Interest

10.434

22.640

12.995

Float

17.230

99.950

39.370

% of Float

60.56

22.65

33.01

Analyzing these numbers is more an art than a science. However, it’s probably fair to say that in times when the overall market is neither excessively bullish nor bearish, a short position of some 20% of the float is fairly large. From this perspective, both VECO and CREE face reasonably significant short positions at 33% and 23% of the float respectively. Neither, however, remotely compares with the size of the short in Rubicon.

Short positions can of course remain embedded for a significant period of time. Moreover, the current negative performance of the overall stock market may well help the shorts extend their recent gains further. However, if heavy short positions suppress the valuations of companies with solid earnings growth for an extended period of time, the answer could well be an LBO or other takeover activity.

In the end, Rubicon is a good company with solid revenue and earnings growth. The immediate outlook for the stock is probably more about the broader issues facing the US market than it is about anything else. However, at these levels, Rubicon looks attractive from a medium-term perspective. Twelve months from now, today’s price levels will probably be looking very cheap. And for anyone prepared to take a one year view, it’s good to be adding when a stock is beaten down and the shorts have done a significant amount of their selling.

Finally, if the overall stock market manages to get itself together, there could be room for a significant short squeeze in Rubicon. There is strength in numbers. But that is never true in an over-crowded trade.

Disclosure: Long RBCN, Long CREE

Source: In Defense of Rubicon - Massive Shorts Show Overcrowded Trade