Travelzoo Short Interest: Electronic Communication Networks Are In Control

| About: Travelzoo Inc (TZOO)

As the volume of trading in Travelzoo (NASDAQ:TZOO) shares dries up, we feel it is becoming apparent that Electronic Communication Networks such as Instinet are in complete control of the direction and short interest in TZOO. ECNs are a topic of the book "Broken Markets" which describes the role of High Frequency Trading or HFT which the authors say are ruining the markets and also believe were the cause of the "flash crash" in May of 2010. We believe there is merit to their argument. We also believe that a flash crash could also happen in the reverse where ECNs are harboring a huge short interest in a stock such as TZOO.

The authors of Broken Markets contend that these trading platforms are in virtual control of many stocks and are trading between each just like shills at a gaming table who are compensated by casinos to attract innocent unsuspecting patrons to their game of chance only to be fleeced of their disposable income. The platforms are compensated by the ECNs in the form of rebates which virtually guarantees them a profit. TZOO shares have been stuck in a very narrow trading range over the past 45 days and it seems these ECNs may be trying to reduce their exposure to a short squeeze just in case the undervalued company and its control obsessed shareholder, Ralph Bartel, make good on a rumor that they are shopping the company to strategic customers who could use the cash flow, revenue and customer base in an accretive deal.

The metrics used in the recent M&A deal for Bleacher Report which sold for 5 times revenue would translate to a valuation of at least $800 million or $50 a share for TZOO not including its cash on hand. Therefore, we believe that traditional short sellers have left Travelzoo which they once saw as a bubble stock. This can be seen in the current negative rebate of 5% (the annual cost) being charged to those desiring to sell the shares short. This is a new low for the year; it hit its high at just over 100% when the shares short totaled over 5.2 million. Other stocks with a high short interest ranked by the "days to cover" ratio (TZOO currently stands at 15.553350) have at least double digit borrowing costs ranging from 10-25%. The drop in the cost to borrow is not in line with the drop in shares short given the increase in the days to cover ratio. We believe they are being reported as short by the ECNs who are creating the volume for HFTs.

During the trading day, it is evident that many of the shares are not traded on the Nasdaq platform because they report a volume of shares traded at approximately half that reported by sites such as Yahoo and Bloomberg. Only after the market close does the total volume come into parity.

In conclusion, if the markets are manipulated as Broken Markets suggests, we contend that investing in a highly shorted cash generating company with no debt can present an opportunity for aggressive investors.

Disclosure: I am long TZOO.