By David Sterman
With the market showing no clear direction at this point, it pays to stay focused on long and short ideas for your portfolio. In recent weeks, I've been trying to generate more short-oriented ideas for readers, and it pays to stay abreast of these picks even more closely than your longs. (Even more important, if you own any of the stocks I've identified as shorting opportunities, you should take a long and hard look -- and consider selling.) The rationale behind a short idea can change very quickly, while long-oriented ideas can often take a year or two to reach fruition.
With this in mind, here's a fresh look at three stocks I've recently panned. With third-quarter results now in the bag, do the respective investment theses still hold up?
- Clearwire (Nasdaq: CLWR)
I issued a dire forecast for this stock roughly a month ago, suggesting the stock might eventually go to zero.
A fast-dying relationship with Sprint (NYSE: S), a key investor, likely spelled real hardship as Clearwire seeks to raise another $1 billion to help complete its 4G wireless network. The loss of sales leads generated by Sprint also looked to create havoc on the income statement.
(For a fuller explanation of Clearwire's challenged business model, be sure to read my original analysis here.)
Well, the on-again-off-again relationship with Sprint may be back on (the two parties are in discussions), and this stock has rebounded more than $0.50 since I recommended shorting it. Still, the long-term challenges remain, so I still expect this stock to fall well below $1 by the end of 2012. However, an actual move to zero may now be less likely since bankruptcy may be averted. Here's why:
For starters, Clearwire was able to maintain its impressive momentum in the last quarter, even as the Sprint relationship was starting to crumble. The company added 1.9 million net new subscribers -- a 29% sequential jump. The current subscriber base will be reasonably sticky, providing Clearwire with a base of recurring revenue while it scrambles to find new partners. (The total tally is likely to exceed 10 million subscribers by the end of this year). Still, this business model is not quite big enough yet to be self-funding: Clearwire posted an EBITDA loss of $46 million in the third quarter.
And as noted in the past, Clearwire hasn't been able to complete the full development of its network, and its financial woes may keep this from ever happening. The company just announced plans to reduce its 2011 capital budget by $100 million, and unless it can raise more money, CapEx may grind to a halt in the first half of 2012. Meanwhile, wireless service providers such as Verizon (NYSE: VZ) and AT&T (NYSE: T) continue to pour heavy investments into their 4G networks. Any early lead that Clearwire created is quickly evaporating.
In the quarterly press release, management tacitly admitted that an inability to raise more money could imperil the business model: "We are not able to update our guidance on our funding needs and our ability to generate positive EBITDA at this time." Translation: potential investors aren't knocking down our doors to provide us with more capital, and until that happens, we're hard-pressed to forecast how the business will fare in 2012 and beyond. In my view, Clearwire will survive and receive more capital infusions, but at prices far below the current level.
- Eastman Kodak (NYSE: EK)
The outlook remains equally dire for this former “Nifty 50" stock, as I first noted in mid-October. Shares have fallen more than 20% since then and have a lot more room to fall, if just-released quarterly results are any guide. Third-quarter sales fell 17% (though only 5% if a major royalty payment from a year ago is excluded from comparisons). More important, another $200 million flew out the door this quarter, and unless it can line up a buyer for its patent portfolio, the company may be hard-pressed to survive into next summer without declaring bankruptcy.
Cash has dropped from $1.6 billion at the end of 2010 to a recent $862 million -- a trajectory that is clearly unsustainable for a company with $673 million due as the current portion of its long-term debt, $1.36 billion in other long-term debt, and $2.5 billion in underfunded pension liabilities. With each passing month, bankruptcy looks like the wiser option -- unless Kodak can sell off its patents. Even if this happens, the remaining core businesses are of uncertain value, especially in light of the company's nearly $4 billion net debt position. If you're short this stock, then it looks like the smart play is to stay the course.
- LinkedIn (Nasdaq: LNKD)
Unlike Clearwire and Eastman Kodak, this isn't a business in trouble. Instead, its stock simply looks quite overvalued. As I wrote in late September, "This is a company worth $7.3 billion, but with just $121 million in sales and $5 million in profits in its most recent quarter. Of course, the company is growing very quickly and investors are counting on strong growth to continue for an extended period."
What do just-released quarterly results tell us? Well, as expected, LinkedIn is still growing at a fast pace -- for now. Third-quarter sales rose roughly 15% sequentially to $140 million, ahead of the $127 million consensus forecast. Frankly, that consensus forecast looked awfully conservative in light of recent quarter-over-quarter gains, and the stock rightly fell about $5 in after-hours trading. (A subsequent announcement that the company would issue new shares in a planned $100 million offering pushed shares down even further.) The stock is now roughly flat since the time I recommended shorting it (while the S&P 500 has risen almost 10% in that time frame).
Where to from here? I still suspect that there's a lot more downside than upside in this stock, beginning the minute investors start to see that double-digit sequential sales gains can't be maintained. By a variety of metrics, LinkedIn grew roughly 50% to 65% from this time last year. (Membership grew 63%, while page views rose 51%.) That works out to a low-teens rate on a quarter-over-quarter basis. Better monetization helped sales grow at almost twice that pace, but you can't assume continued higher monetization and instead need to think of this business model in terms of those membership metrics.
All of this is not meant to imply that there is anything wrong with the LinkedIn business model. It's a solid and sustainable growth platform. It's just that the $8 billion market value anticipates more growth than the company can reasonably deliver. In my analysis in late September, I noted that 25% annual sales growth (beginning in 2013) and 40% annual earnings per share (EPS) growth still only yielded $1.86 billion in sales and $1.34 in EPS by 2016. Let's assume that's too conservative and sales reach $2.2 billion and EPS hits $2. At around $80, or 40 times what 2016 EPS might look like, this stock remains too richly valued and should remain in focus for short-sellers.
Risks to Consider: Clearwire and Eastman Kodak may still manage to secure a financial lifeline and their stocks would quickly rally on such news. So these are high-risk shorts. LinkedIn represents less risk, as the stock can move up a bit from current levels, but still looks poised for a steady downdraft as long-term growth assumptions start to get dialed down.
Peppering in these short plays amidst an otherwise long-oriented portfolio can help protect you from a renewed bout of market weakness. Any one of these stocks looks like a suitable short from where I sit.
A slowing economy would prove especially perilous for Eastman Kodak and Clearwire as these companies remain unprofitable and will surely need further injections of capital. LinkedIn, on the other hand, is simply too richly-valued based on its current growth trajectory.