Why I'm Again Short Rosetta Stone

| About: Rosetta Stone (RST)
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Declining revenues are only being masked temporarily.

A decline in deferred revenues will be the last shoe to drop.

The business model will not be long-term sustainable.

Several months ago, I laid out a bearish case against Rosetta Stone (NYSE:RST), and on a short-term trading basis, it went very well. In the last two weeks, I have again taken a short position on RST before earnings and the thesis is very similar.

The previous article can be found here.

Basically, the Rosetta Stone situation is all about deferred revenue, which although has been growing steadily, the revenue stream (which is more and more predictable) has fallen dramatically. As of the end of Q1 2016, deferred revenues were up to $132 million, of which $99 million was under the current liabilities section of the balance sheet - $99/12 months is approximately $25 million per quarter.

The total revenues for RST on an annual basis have been on the decline since 2012. Total revenues have been:

2012 - $273

2013 - $264

2014 - $262

2015 - $218

2016 Q1 revenues were $48 million, down from $58 million the same quarter a year earlier.

The bulls have argued the turnaround at RST is only beginning. Effectively, the company is moving from a one-time marketing and selling of its product to an individual consumer to a reoccurring subscription-based model. The problem with this approach is the software is not essential, and in a world where every company is cost conscious and other similar products can be had for free, RST will be further challenged.

Essentially, the loss per share has begun to narrow, but with a "single skew" type of approach like RST's, the declining revenue or receding of the tide may be only beginning. Having taken a short position around the earnings on a few occasions in the past year, I have had the opportunity to listen in on the conference calls and have witnessed the euphoria from one analyst several quarters ago to a completely mum audience of analysts on the 2016 Q1 conference call.

I believe those paying close attention to the company already are aware the tide has turned, and potentially after earnings on August 3, 2016, the stock price will finally move down from the $8 range it has kept for the past several weeks to the range where it belongs. It's hard to say where the range is though.

Currently, with no debt outstanding and $40 million in cash on the balance sheet, the company may take a long while to arrive at its judgment day or be bought out.

Maybe that's where the analyst's euphoria came from on the conference call several quarters ago: either an attempt to do a deal or get some investment banking business. This I have no proof, however, it's only my own supposition.

Given the time frame and potential buyout, I think the $4 per share price range may be in the right ballpark, but we'll have to see what the "street" thinks in a few days.

I shorted the shares of RST in the past several weeks at a price above $8 and have not written or bought any options. Although the revenue may be predictable, a decline in deferred revenues may sink the stone.

Disclosure: I am/we are short RST.

I wrote this article myself, and it expresses my own opinions. I am not receiving compensation for it. I have no business relationship with any company whose stock is mentioned in this article.