Weekly Short Newsletter (Week Ending August 16, 2019)

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Includes: BE, BTU, C, CHGG, CTSO, DCGD, DVA, HIIQ, KEG, MD, NFLX, OHI, OSTK, STMP, TRUP, TSLA, VRAY, WFC
by: Jan Svenda
Summary

In this week’s newsletter, we highlight a Short report about an eyeglass retailer that is seeing pressure on margins and growth.

We also summarize recent Short theses on a troubled healthcare REIT, a pet insurer that has now shown that the business model is breaking apart, and also a classic OTC corporate governance Short.

We highlight a previous Short idea that successfully predicted the fate of a speculative medical device.

This Weekly Short Newsletter is normally exclusive to PRO+ Subscribers. We're making this one available to all readers. SA PRO+ is our institutional-grade subscription offering targeted to buysiders and serious investors. If you enjoyed this report, and would like to subscribe or learn more about Exclusive PRO+ benefits, click here or email the PRO team at pro-editors@seekingalpha.com.

PART 1: Review of the week's Short Ideas - Column written by Jan Svenda

We begin by summarizing Short Ideas from the week, and we will drill down on the thesis on an eyecare retailer.

1. Trupanion (TRUP)

The Capitolist continued to pile on this pet insurer that I highlighted last week.

The author came up with new information that is significantly supporting the case for the Short. Most importantly, TRUP is requesting a 20% hike in prices for their insurance rates in California, one of the major markets for the company.

This is on the back of previous hikes in the past four years. Cumulatively, TRUP raised prices by 150.3% in the state.

The trouble with this is two-fold.

First, the competition is likely to enjoy further growth because of this move. TRUP is the priciest provider of insurance out there and this will only cement this. Thus, consumers are likely to shy away from it and move to other providers. This should mean that TRUP’s slowing growth will decelerate further.

Second, the contributor judges that TRUP is not doing the hike because they want to enjoy increased profits; rather, they are doing it to offset decreasing margins (increasing loss ratio). This suggests the company may need to enact such hikes regularly to keep up appearances. This should fuel a negative cycle of slowing growth and deteriorating margins.

Given the fact the share price is still holding up relatively well, The Capitolist sees plenty of downside.

I would note that even Craig-Hallum, a sell-side firm covering TRUP, has downgraded its rating and mentioned similar negatives.

2. Omega Healthcare (OHI)

Beyond Saving shared a Short thesis on a healthcare-focused REIT.

The article suggests that OHI is at risk of losing several of its top tenants because of their financial condition. In fact, one of the Top 10 tenants already went bankrupt. OHI lost more than 10% of its FFO and barely covered its dividend. Yet the stock keeps on holding up.

The author believes, as further bankruptcies are likely, the REIT's dividend is in danger of being cut. Since REITs are often traded on yield, this would then present a clear opportunity for a downturn in the share price.

Specifically, the report talks about Daybreak, a Texas healthcare company facing potential bankruptcy. It has signaled structural cash flow problems given the current healthcare environment (low Medicaid rate relief). This could be the ultimate catalyst that should set off both the fundamental deterioration and share price slide.

3. Discovery Gold Corp. (OTCPK:DCGD)

White Diamond Research (WDR) has written about this OTC entity which recently saw a strong surge in the share price.

The report suggests that the stock move seems completely disconnected from the fundamentals. DCGD is, for now, a corporate shell with no assets, which was confirmed by the recently filed 10K. Thus, the current market cap in excess of $100 million is not reasonable.

Moreover, the contributor finds that the CEO of the entity has claimed to be a Harvard graduate in previous SEC filings. After checking with the Harvard registry, the contributor is disputing the CEO's education credentials, as there is no record of CEO Costello ever graduating. The CEO has also touted his experience as a fund manager and the entities connected to this. However, it seems that the main entity, GRN Funds LLC., is not even registered as an investment advisor, casting further doubt about the whole company.

All this makes DCGD look like a classic OTC pump and dump which Short sellers could potentially take advantage of.

I would personally add that it appears the CEO has started backtracking on previous SEC filings in this letter released a few days after WDR’s report. He specifically states he did not graduate from Harvard. He writes he does not know where this information comes from despite signing a filing in July with this exact wording;

Mr. Costello is a graduate of the University of Minnesota in Public Business Administration and a graduate of the Harvard Business School.

4. A detailed review of National Vision Holdings (NASDAQ:EYE)

This week I decided to drill down on a different target for The Capitolist: a value retailer of eyeglasses and contact lenses in the United States.

  • Summary

The Capitolist sees several problems with EYE.

The first one is connected to how the stock was formed. EYE was taken public after private equity groups bought out several eyeglass brands that were in bankruptcy and restructured them. The bankruptcies came as a result of the cutthroat business environment of the industry which is saturated and low-margin.

While the company itself is now profitable, the underlying business model raises questions because of this troubled history of the underlying brands. Especially since EYE now wants to continue to grow its store footprint, effectively expanding the business model.

They want to do so despite the news that Luxottica merged with Essilor, which will put additional pressure on the already strained secondary players.

This pressure is likely already visible as the growth rate of EBITDA is slowing down. Furthermore, EYE is producing only a 1.5% FCF yield, which compares poorly to the broader market and raises questions about valuation.

The second major problem visible with EYE is the way they present their results and how are they adjusting common SEC metrics.

Perhaps most importantly, EYE routinely ‘adjusts’ EBITDA for one-off costs which do not seem to be one-off at all (for example pre-opening expenses for stores etc.). These ‘addbacks’ are also growing every year.

EYE also uses dubious adjustments when it comes to same-store sales, usually a straightforward metric. For example, they have expanded the length of time the company excludes new stores from the metric. Usually, the new stores are excluded until they hit a full year of operation, i.e. 12 months. EYE for some unknown reason is now using 13 months.

The third problem mentioned in the report is related to advertising. The report shows that EYE’s staple deal of getting two pairs of glasses and a free exam for $69.95 could be an example of ‘bait and switch’ technique which the FTC might want to inspect.

According to the author, the adverts are not clear that the free exam only applies if you purchase the glasses. The deal is also only applicable to a specific type of eyeglasses that usually consumers upgrade from. Thus, it seems the advert is luring them in, but then the consumer ends up paying much more.

All of these problems should present downside risks. The Capitolist sees 50% downside from current prices, possibly more if FTC does get involved.

  • Jan’s Take – Interesting new target

My decision to highlight EYE here is because it is novel idea with straightforward dynamics.

There were only two other articles written about EYE, both back near its 2017 IPO. Since then the stock has traveled without much scrutiny. There are no articles on Value Investor Club and others, while Twitter had only few mentions before several tweets from the Capitolist. The sell-side does cover the stock but does not seem to update their view frequently.

The short interest for EYE now stands at 11% which indicates some modest interest.

Thus, investors may have a chance to get out ahead of the curve on this one.

Disclosure: The author Jan Svenda has no positions in any of the stocks featured in Part 1.

PART 2: PRO+ Short Top Idea Playing Out (HSDT, January 11, 2019)

Near the beginning of the year, White Diamond Research presented their research on Helius Medical Technologies (OTC:HSDT). The company is a pre-revenue single medical device company, with an instrument intended to treat brain injury through electrical stimulation of the tongue.

Arguing that the device was effectively a placebo, that any positive trial results were due to physical therapy benefits, that Helius' changed endpoints of the studies, and that even if approved the device would not generate meaningful revenues, White Diamond argues that the stock should eventually approach zero.

To a large degree, that has been the case:

The stock suffered a significant drop on April 10, 2019, on news that the FDA rejected Helius' Portable Neuromodulation Device (PoNS).

Further, right in line with White Diamond's concern, the FDA cited the lack of sufficient information to determine the relative contributions of the PoNS device and physical therapy in its clinical trials.

Meanwhile, the company has burned through more than $11m in cash over the past 2 quarters, and was sitting with a liquidity balance of ~$14m at the end of June. That cash resulted from a secondary offering at $8.25 per share back in November 2018.

Shares of HSDT are now more than 75% below that price, and also more than 75% lower than when White Diamond presented the Short idea.

PART 3: Full List of Short Ideas (Week ending 16th of August):

We break-down Short ideas into 4 categories:

  • Event-Driven

This category includes short ideas which are based on an event that should play out in the short-term, negatively affecting the company.

Wells Fargo's Decline May Only Be Starting

  • Corporate Governance

Short ideas focused on various red flags that are tied to the management (ie - dubious executive decisions, poor track record, insufficient disclosures, questionable accounting)

Market Significantly Underappreciates Magnitude Of Teladoc's Relationship With Health Insurance Innovations

Misleading Operating Lease Discount Rates Obscure Reported Results

  • Macro Thesis

Short Ideas where the company in question is facing broader business trends, including broad-based competitive pressures.

Another Quarter Of Losses At Key Energy Services

Netflix: Carrying Capacity, Competition, And Cash Burn

Citigroup: Get Out While You Can

Peabody Energy: The End Game

  • Weak Fundamentals

Worrisome company fundamentals, or where fundamentals simply don't justify the stock price.

Cytosorbents: Revenue Could Decline 70%+ In 2022

Mednax: Don't Get Seduced By Cash Flow, The Business Model Is Breaking Down

Stamps.Com: Fragile, Handle With Care

DaVita: Negative Trends Still Visible In Q2 Results; Reiterate Sell

Overstock: Negative Reality Lurks Just Around The Corner - Short With 90%+ Downside

ViewRay: Failed Product Launch Raises Solvency Questions

Bloom Energy Warns Of Much Weaker Than Expected FY2020 Performance

Omega Healthcare: Top 10 Tenant Stops Paying Rent, Stock Price Goes Up

Trupanion: $8 Price Target, Adverse Selection Exposed In Filings

Evaluating Chegg's Competitive Advantage

  • Tesla Articles

Given the ongoing popularity of shorting TSLA we have dedicated a standalone category for it.

Tesla: Enjoy The Valuation Premium While It Lasts Because It's Going Away

Tesla: Production Is A Sensitive Topic Now

Tesla's Model 3 Sales In Europe Declined In Q2, July, And Aug. 1-9

Be sure to use our Idea Filter to scan and filter for other Ideas that may fit your investment criteria.

- Wishing you a successful day.

SA PRO+ Editors Team (pro-editors@seekingalpha.com)