Looking over the most recent short-interest data, a very unusual
company jumped out at me:
EMC Corp. (NYSE:
. Short-sellers are increasingly convinced the storage giant is
headed for a fall.
In the last two weeks of April, they boosted the short position in
EMC by 18% to 83 millionshares . That makes EMC the seventh-most
shorted stock on the New York Stock Exchange. Said another way, the
percentage increase in short interest is the largest of any company
in the Nasdaq 100.
Trying to figure out why so many investors are bearish, I turned to
Wall Street analysts. That didn't help. I read nearly a dozen
reports and almost every single analyst appeared very bullish on
EMC's prospects, with almost all of them predicting
will rally higher as the year progresses. Turns out, we've got a
battle of bulls vs. bears.
Let's look at each case.
The sell-side frenzy
Wall Street analysts, known as sell-siders, repeatedly take note of
the fact that EMC operates in one of the hottest areas for
high-tech spending -- storage. Many enterprises are buckling under
the weight of all the data they must harness, and they keep adding
more and more storage servers to handle theload . EMC is considered
to be the "best of breed," meaning its products are pricier -- but
more robust -- than storage products sold by larger vendors such as
By Wall Street's logic, overall tech spending will grow by
single-digits in 2011, demand for storage could grow about 10%, and
EMC, thanks to
gains, can grow at least 15%. Sales had grown at an average annual
rate of about 9% in the past three years. "We're beginning to think
aloud if EMC's most robust opportunity actually lies in front of
it," wrote analysts at Brean Murray in a January, 2011 report.
That robust opportunity? Cloud computing. An increasing amount of
corporate data is being placed at Internet-connected data centers
where EMC's specialized hardware and software help keep the massive
of information flowing. EMC's 80% stake in
surely helps. The two firms, in conjunction with partner
Cisco Systems (Nasdaq:
, have seen their Virtual Computing Alliance (VCE) attract
considerable buzz among IT executives.
A monthly survey conducted by Goldman Sachs in April that looks at
IT spending plans found that "EMC is the standout gainer," adding
that "EMC's gains were notable across storage and hardware." This
means whatever IT spending funds are available in 2011 could well
include EMC as part of the program.
Legions of doubters
Yet it's that IT spending outlook that may actually prove to be an
Achilles Heel for EMC investors. The nuclear crisis in Japan, the
economic crisis in Europe and signs of an emerging economic
slowdown in the United States have tech watchers concerned that the
industry has already crested and is due for a reckoning.
Just this week, Hewlett-Packard shaved its 2011 revenue forecast by
$1 billion. HP may not be as strong a player as EMC in storage, but
both firms share the same global customer base. "There's concern
about a slowdown in economic growth. If that is the case, it will
not only have an impact on a company like HP. It will affect the
broader market," said Robert W. Baird's market strategist Bruce
Bittles in an interview with Bloomberg. Can EMC really match the
consensus forecast of 16% sales growth in 2011 if IT spending is
EMC's detractors also take note of a few other issues. For
starters, they note that more than half of the company's value is
reflected in its 80% stake in VMWare. That firm, which admittedly
has considerable momentum, is valued at more than 10 times
projected 2011 revenue. That's an awfully high multiple for a
company that has already grown quite large. So why not short shares
of VMWare directly? Because very few shares are actively-traded,
due to EMC's controlling stake, and it's much easier to short
shares of the more
EMC stock and bet that both entities will drop in value.
Even Goldman Sachs' analysts, who highlighted positive survey
responses for EMC, inject a note of caution. Their April survey
generated a reading of 68.0, down seven points from the March
survey. "Looking ahead, we believe IT spending expectations will
have to balance secular growth drivers against an easing cycle
recovery, tougher annual comparisons, and weaker key macro data,"
they wrote in a mid-May report.
Other short sellers suggest EMC's growth rate is bound to slow,
simply due to the law of large numbers. Indeed, Merrill Lynch
forecasts EMC's per share profits, which rose 40% in 2010, will
grow 24%, 15% and 13% in 2011, 2012 and 2013, respectively. And
that forecast assumes a robust outlook for storage spending. If the
weakens, EMC's growth rates would be notably lower than Merrill's
Action to Take -->
Shares of EMC powered higher through the winter and have held their
own in the spring, even as other tech stocks have started to
stumble. Short sellers are betting that the stock's surge, which
has pushed it up to more than 20 times trailing
, is simply too rich for such a sober current environment for tech
spending. In the next few quarters, we'll get a clearer sense of
who will emerge victorious in this battle between bulls and bears.
Although EMC looks like the best house in a bad neighborhood, a
real case can be made for a slowdown in tech spending. The company
may be hard-pressed to keep growing at the fast pace that many Wall
Street analysts expect.
-- David Sterman
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Disclosure: Neither David Sterman nor StreetAuthority, LLC hold
positions in any securities mentioned in this article.