GreenHunter: Better Short Selling Opportunity Than Trading Against SAC

| About: GreenHunter Resources, (GRH)

The latest news on Steven Cohen and SAC is that SAC has been arraigned on numerous criminal charges related to insider-trading. The sharks are in the water, looking at trading against SAC on the potential wind-down of its investments. There was an article on about this earlier in the year, and I was recently pitched on a particular short thesis.

The short I was pitched is American Realty Capital Properties (ARCP). ARCP is a property acquisition company that was taken public in 2011 to take advantage of dislocations in the real estate market. It did poorly after its September 2011 IPO but recently has traded up to $14.65 and was almost at $18 in early May, versus a $12.73 share price after its IPO. The short thesis is that SAC owns stock in the company (it was pitched as SAC's largest position, which is obviously not true - as of the last filing, SAC owned ~1.4% of the outstanding stock, or a ~$31 million position). The thought is that SAC may be forced to liquidate its positions in the aftermath of criminal arraignment. Thus selling in advance of SAC's liquidation of positions could essentially front-run SAC and earn profits from SAC's liquidation.

This thesis is problematic for several reasons. First, as can be seen in the ZeroHedge article, SAC's largest position as of the publication of that article was 1.56% of AUM. This means SAC is extremely diversified and could selectively liquidate over time to avoid material impact on any particular stock. Second, as evidenced by the ARCP position, SAC rarely holds more than a small percentage position in any particular company, further reducing the probability of a price impact of liquidating positions.

And third, SAC has a long track record of compounding money at a 25% rate of return after fees. Which would be extraordinary even if SAC weren't charging 3% management fees and 50% of profits. Before fees, this implies performance over 50% annualized. I would not want to intentionally bet against specific investments made by a firm with such a strong track record.

Instead, I have recently shorted a much smaller oil services / "clean tech" company. It has numerous issues, but I will focus on the most obvious one that is statistically predictive of negative equity performance over time.

The stock I've been shorting is GreenHunter (NYSEMKT:GRH). One of the reasons I've been shorting it is that the CFO of the company resigned recently and the company did not have a replacement lined up. According to this Mercer study on executive turnover, "the strongest predictor of stock price decline [in the context of executive turnover] is whether there is an immediate replacement executive ready to be named as the successor."

Another reason I have been shorting the stock, other than the CFO resignation without a replacement, is that GreenHunter's EBITDA for 2013 will likely be ~$2 million, which is less than half of the $4.6 million in preferred dividends that GreenHunter will have to pay in 2013. So far, preferred dividends have been paid through equity and preferred issuance, which is obviously problematic and unsustainable.

This ties into another issue - amount of capital and capex invested versus current valuation. In total, GreenHunter has spent ~$25.8 million. This compares unfavorably to a $110 million enterprise value, with $46 million of that preferred stock. There is almost twice as much preferred stock (at par) as assets at cost. This is a big red flag, particularly considering the low level of cash flow being generated by these assets and the insufficient cash flow to cover the preferred payments.

And of course, the going concern warning in the 10-Q is, for lack of a better word, concerning. It is consistent with the observations of lack of cash flow coverage for the preferred dividends and the limited asset coverage relative to the quantity of preferred stock outstanding.

Shorting a stock based on a strong empirical "predictor of stock price decline" is quite the contrast versus trading against a firm with a multi-decade track record of 50%+ compounded rate of return. And of course, the other reasons mentioned made the trade even more compelling to me.

Disclosure: I am short GRH. I wrote this article myself, and it expresses my own opinions. I am not receiving compensation for it (other than from Seeking Alpha). I have no business relationship with any company whose stock is mentioned in this article.

Additional disclosure: I am short GRH and may buy or sell it or any other security mentioned at any time without further notice. I have no relationship with SAC or any SAC-related entity, to the best of my knowledge.

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