The prospects of a short squeeze, along with the share price of a stock holding up in a plunging market, may be a tempting buy for some speculators.
This rationale seems to have propelled Redbox Entertainment (RDBX) to recent gains of 200% in June. The short-squeeze momentum move has taken Redbox shares to heights that are so out of line with its fundamentals that buyers are playing with fire, risking significant losses.
Redbox is the DVD kiosk and streaming video company. Last November, Redbox closed a deal to go public after finalizing a merger with a special purpose acquisition company (SPAC), raising $88 million used to pay down debt. Redbox had been private since 2016 when it was acquired in a deal with Apollo Global Management (APO) .
The problem for investors is that the legacy DVD business, which at more than 85% makes up the lion's share of Redbox's revenue, is in clear decline, money-losing, and with minimal hope for recovery. In the first quarter, revenue in the legacy business declined 28% year over year to $49 million. In the 12 months ended in March, Redbox lost $186 million on $352 million in revenues.
The outlook for Redbox's business prospects is so poor it agreed to be acquired in May for the equivalent of 67 cents in an all-stock deal by Chicken Soup for The Soul Entertainment (CSSE) . Short interest had begun to ramp up prior to the deal on bankruptcy concerns, only to increase further on the deal lifeline at a depressed equity valuation. As of May, short interest stood at 4.1 million shares, up from 1.1 million two months earlier.
Like meme stocks of the recent past, speculators seem to have grasped the high short interest to pump the short-squeeze potential. In the short run, the strategy seems to have worked, but the move higher is not likely to last long.
There are two problems with a continued short squeeze. First, the short interest appears high relative to float, though it's small relative to the shares outstanding. Redbox has about 45 million fully diluted shares outstanding, more than 10 times the shares shorted. Insiders undoubtedly will look to sell shares into this non-fundamental related move higher, which would significantly increase the float and lower the short interest percentage.
Second, Redbox is a leveraged, money-losing enterprise in need of substantial capital. Wedbush's analyst believes the company faces bankruptcy without a cash infusion and that the stock to be worth 50 cents with or without a deal.
Like other meme stocks, Redbox likely will sell shares to stabilize its balance sheet. This may put the DVD kiosk company on firmer financial footing, but shareholders will still face dilution and far less momentum to continue a short squeeze.
Redbox's board of directors and top shareholders favored selling the company for the equivalent of 67 cents. Speculators are banking on insiders holding on tight to their shares even though they are demonstrably overvalued. Hoping that meme stock irrationality continues to reward buyers is folly for a company in desperate need of fresh capital.
Shareholders ought to exit stage left before Redbox goes the way of the DVD.
