Tracking the Shorts

 | Sep 26, 2013 | 3:00 PM EDT
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One of the more interesting market checks I run from time to time is looking for stocks that are heavily shorted. Some of them, such as BlackBerry (BBRY) and J.C. Penney (JCP), are shorted for good reason. They are not-so-great companies that are having a terrible time fixing the business. Some are suspected on accounting missteps and other shenanigans and could implode when exposed.

In addition, there are usually a lot of biotechs such as Dendreon (DNDN), where traders are betting against the approval or success of some new drug application. However, every time I go through the list of heavily shorted stocks, I find a couple that make me wonder what the short sellers are thinking. They may not be cheap by my standards just yet, but they trade at pretty reasonable valuations and have decent prospects. Any sign of good news could send the shorts running for the hills and lead to nice pop in the stock price.

Blyth (BTH) may not have a collection of incredible businesses, but people seem to buy the candles and household doo-dads they sell. There is no moat but there is no reason for the company to fail -- selling tacky stuff via catalogs and the Internet has always been pretty successful in the U.S. More importantly, insiders own one-third of the outstanding shares and have been buying more in the past few months. It looks like 61% of the float is sold short right now by traders betting against the company. It is a classic battle of shorts against owners. If I were a trader, I would take some of the cash I was using to chase Apple (AAPL) all over the board and have some sort of bet on the battle.

I suspect the shorts in Erickson Air Crane (EAC) are making a sequester or government shutdown bet of some sort. This manufacturer and operator of Erickson S-64 Aircrane (S-64) heavy-lift helicopters does a lot of business with the government and government contractors. In addition, there is the usual flurry of lawsuits swirling around over its acquisition of Evergreen Helicopters earlier this year. Management is accused of insider dealing in buying the distressed company from a hedge fund. They are also taking on new debt to buy Air Amazonia a Brazilian aerial services company, which includes a fully operational fleet of six rotary-wing aircraft of varying types and mission capabilities.

The company is still in business and winning contracts and actually appears somewhat cheap to me. The shares trade at 10x earnings and right around 1.5x book value, so they are not overpriced. A quick and dirty calculation shows the stock to be worth about $20 a share or about 30% higher than the current share price. And 42% of the float is sold short, so any measure of good news could park a short covering rally.

I mentioned magicjack VocalTec (CALL) earlier this year as a stock that has the type of numbers that might appeal to a private equity investor. The company has an EV/EBITDA ratio of just 3.5 and no debt on the books. The most recent quarter disappointed some shareholders, but the company has been growing earnings at 20% a year and should continue at that level for several years at least. Initial sales of the new 2014 MagicJack PLUS have been strong and the company is planning to expand its voice over Internet Protocol (VOIP) offerings to the international markets later this year. Currently, 34% of the float is sold short and this company could deliver positive news that sends the shorts scrambling to cover before the year is over.

Only one of my current holdings makes it on the list: Short sellers are still betting heavily against Cliffs Natural Resources (CLF). They may be right in the short run, but I really like this stock as long-term holding. The global economy is eventually going to grind out a sustained recovery and the current excess supplies of iron ore will be absorbed and the company will see stronger revenues and earnings. I wouldn't be upset by a short-covering rally -- and with about a third of the float sold short, it's not out of the question on any better economic news.

Tracking the shorts is not something I do every day, but once in a while it is a worthwhile exercise. Short sellers quite often get it right -- but when they do not it can lead to some pretty spectacular gains when they throw in the towel.



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