Sifting Out Worthy Spec Plays

 | Sep 05, 2012 | 7:50 AM EDT
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Taking a flier is a well-established way to lose money. But what if you don't? What about the show-me situations that show you?

I have been very averse to recommending any stocks that sport low-dollar prices. That's because, first, every time I mention one on air people go nuts for it -- and second, after people go nuts for it, these stocks tend to go lower when nothing immediately happens to warrant the rise.

I understand the natural proclivity here. The same people who would never buy a single share of Apple (AAPL) would gladly by 600 shares of some dollar stock that's much dicier and with much dimmer prospects. They like that low-dollar amount. They aren't dissuaded by the quality of the merchandise. They can't resist the so-called bargain. They think they are catching a diamond at a dollar store.

I am not going to change my philosophy of uber-skepticism about these kinds of low-dollar stocks, and I will never, ever recommend a penny stock. That's too risky, and the odds are too great that the penny stock may constitute some sort of a boiler-room scheme. Many stocks below $1 are scams, and no good management team aspires to have a penny stock on its hands simply to inspire retail interest in the company.  

But recently I have been reminded that it's OK to take that flier if you have a legitimate thesis and if you think the stock is very mispriced.

Specifically, I have lately had brushes with three low-dollar stocks that have worked, and worked well. That's despite the fact that, if you'd bought two of them before they became low-dollar stocks, you still wouldn't have made your money back at this point. These names only worked at the darkest moment before the dawn.

Let's take a moment and go over the stocks that remind me low-dollar risk isn't necessarily a bad thing, and can be embraced if you recognize the possibility of 100% loss if something goes wrong.

First there's Sunrise Senior Living (SRZ). Last year I wrote off this company, putting it in the Mad Money sell block. I had stated that, given what had been a horrid housing market, the elderly couldn't sell their homes in order to move into Sunrise's facilities. I therefore questioned whether it was possible for this company to make it, especially since its balance sheet was so bad.

When I made that call, my old friend Mark Ordan, who had recruited me to Goldman Sachs (GS) in 1982, had recently taken over Sunrise. He said I was dead wrong, and he wanted to come on the show and explain why I was wrong and why his $6 stock was worth an investment.

When Ordan appeared, he talked about how he was able to work with lenders to restructure Sunrise's debt. He said that, while it has become harder to sell all homes in the country, the demographic imperative of senior living played right into the company's hands. Plus, while seniors might be stymied in selling homes, many of them simply had to go into Sunrise because they needed the care, particularly those elderly with Alzheimer's, a disease that requires round-the-clock care for many who suffer from it -- something that the children of those afflicted can't take care of.

He made it very clear that, while the stock and the balance sheet had indeed been compromised, he was fixing the finances, putting a high-quality team in place and setting the stage for a multiyear turnaround.

Ordan was dead right. The market -- and I -- were dead wrong. Sure enough, about a year after he appeared, Health Care REIT (HCN) recognized Ordan's achievements and bid $14.50 per share for the company. That represented a 62% premium to where the shares had gone out the day before, as well as a nice gain on top of an already-hefty advance since Ordan's appearance.

Ordan, who took over when the stock was at $0.27, turned around Sunrise in four years. On the show Tuesday night, Ordan admitted that Sunrise might have been too difficult to speculate on when it was at $0.27, given that the world looked like it was ending and many stocks had traded down to absurd levels. To me, though, the more important point is that you could have bought this stock between $5 and $6 just a few months ago, with the tunaround already in place.

In other words, Sunrise was an accessible $5 spec with a proven CEO who promised a turn and then gave you one.

How about Sprint (S)? Sure, it looked dead at $2 four months ago -- but, like Sunrise, Sprint had a proven CEO and a loved product. Again, that combination produced results that made for a doubled price from those dark moments not very long ago. I don't think the move is over, either. Once the change starts, you get a virtuous circle higher as debt gets extinguished, or replaced with lower coupons. Further, institutions no longer regard the common stock as speculative once it reaches $5. That virtuous circle, of course, replaces a vicious cycle down, wherein more and more money is needed as the service deteriorates or the product gets outmoded. Sprint CEO Dan Hesse turned that vicious cycle down into a virtuous cycle up, and that's how Sprint shares doubled.

How about Heckmann (HEK)? This is the oil-services play that, overnight, has turned itself into the largest player in fracking wastewater remediation and disposal. I know Heckmann is down a lot from the time CEO Dick Heckmann came on Mad Money and made all sorts of promises that he was going to build a world-class oil-and-gas play. Despite the decline, he never stopped trying to bring out value. His acquisition Tuesday of a larger company, Power Fuels, has indeed made Heckmann the only national player in a segment dominated by independents that no one has ever heard of. These include oil-and-gas companies themselves, which are desperate to combat perceptions that the fracking wastewater is so contaminated that fracking should be banned in the U.S.

I didn't give up on Heckmann, even despite the sickening slide down from $6 and change to a little under $3. That is simply because I had made so much money with a predecessor company of his, U.S. Filter, a water-treatment company that Heckmann built from nothing into a giant national wastewater-filtration company. He proceeded to sell the company to Vivendi for $6.2 billion in 1999, just a few years after he had bulked it up, in similar fashion to what he is doing now with Heckmann.

When his forecast for a much higher Heckmann price didn't immediately pan out after he appeared on Mad Money, those who bought it at $6 -- where it was at the time -- grew to hate it and me at the same time. Here, again, explains my reluctance to feature low-dollar stocks on my show. They just attract too much retail interest, which in turn moves the price to unsustainable levels. In fact, it was probably the most scorned stock of any company I have highlighted in the last couple of years.

But, just when the stock had been cut in half -- mostly because of the decline in natural gas drilling, courtesy the collapse in pricing from the domestic glut -- Dick had made the acquisition that turned the company into the largest and most dominant player in the oil as well as nat gas fracking wastewater disposal business. This comes, moreover, at a time when the single most contentious issue with fracking is the irresponsible way that so many fly-by-night operators treat and dump the wastewater.

Suddenly you have a nationwide company that is going to be the gold standard, the one you want to hire if you want the regulators to bless your operation -- just like what Heckmann did with U.S. Filter.

Heckmann answered all my questions with alacrity, particularly one suggested by fellow Real Money contributor Matt Horween. That one inquired as to why, given Heckmann's stock decline into relative cheapness -- if not outright purgatory -- the target didn't accept all stock and not the cash-and-stock deal it received. Heckmann asserted that, by giving the target's CEO plenty of stock, thus making him the largest stockholder, while also giving him cash and a lock-up, the deal put him as much on the same page as the average shareholder. I agree with that candid assessment. 

Suddenly you've got a stock that jumps more than 25% in a day -- and I think the stock can do it again.

When the shares had gotten hammered, I secretly hoped Heckmann would bail viewers out, perhaps with a takeover from the likely source, Clean Harbors (CLH), which is trying to become a soup-to-nuts fracking services company.

Now I fear Clean Harbors will bid for the company before Heckmann can take the stock to $20 a share, where he believes it can go. That may seem outrageous, but it isn't if you consider how he built U.S. Filter out of nothing in a very short period of time.

Sunrise, Sprint and Heckmann turned out to be terrific specs. They made me reflect positively last night on a stock that I have hated forever, Nokia (NOK), if only because it's been down so long that it seems like a relatively harmless speculation, even as it has already risen mightily from $1.63 to $2.80. Don't worry -- that's still down 41% year over year and, of course, it represents a huge decline from its $62 handle a decade ago.

I don't like Nokia the way I do Heckmann or Sprint, although Sunrise is now completed as a spec because of the takeover. Nokia's got too many natural, well-financed enemies, including Apple, which is about to announce still one more Nokia kill in about a week's time.

For myself, I now feel the hunt is on to find more turnarounds that fit Ordan's dictum. In other words, I'll be looking for a good management team that can work with lenders and banks while it restructures the balance sheet and turns around a company with a sterling track record for producing a marque product or service, even as its stock is signaling otherwise. I have to stay open-minded for when there is a serial creator of wealth with a great brand or a great idea -- a person can execute and master the situation for his or her shareholders.

This isn't easy. Again, I am mindful that home gamers get too excited about these kinds of stocks. Still, the events of the last few weeks remind me that not all fliers end in disasters, and if you put a little money in them you can be richly rewarded. They are, indeed, worth it. But that's only if you use the Ordan-Hesse formula for an honest long-term turnaround, or a Heckmann plan to duplicate precious success in a business the CEO knows better than anyone alive.

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