Every two weeks, we get a chance to look at fresh data on how
heavily stocks are being shorted. It helps to see what
short-sellers are focusing on -- especially if you own one of the
stocks being targeted.
You'll often see short positions in a particular stock slowly rise
as an increasing number of short sellers start to sniff trouble at
a company. But it's highly unusual to see a short position rise
from 60 million
to 139 million shares in just two weeks, as I did. It's as if the
entire short-selling community has raced to get on the bus and
watch this stock tumble.
Normally, these short-sellers
red flags in a
and want to bet against a stock before even worse numbers appear in
subsequent quarters. But that's not why they are targeting wireless
Sprint Nextel (
. The company actually delivered pretty decent results during that
interim period between short seller release dates (April 15-30).
Instead, short sellers are focusing on a news item that hit the
wires on April 19, a full week before quarterly
came out. That's when New York State Attorney General Eric
Schneiderman slapped the company with a $100 million lawsuit
alleging under-collection of sales taxes. The scary part: New York
could win triple damages if successful. The really scary part:
other states may follow New York's lead, opening Sprint up to a
in excess of $1 billion.
Since I am not a legal expert, I'll lay out the facts for others to
digest. Sprint claims it didn't owe taxes on sales associated with
out-of-state phone calls. So the company decided to put a reduced
amount of taxes on each customer's bill as a way of cementing its
reputation as a low-cost industry provider. In my cursory review of
the resulting fallout, this is indeed a gray area. Other
communications firms have reportedly adopted similar tactics
without any pushback.
Sprint further believes that even if there is a liability for
unpaid taxes, it's the responsibility of consumers to make good on
their unpaid taxes, not the company. Sprint would obviously like to
avoid that route, knowing it would make its customers irate to
receive a one-time $100 bill for past unpaid taxes.
A settlement in the works?
One thing is for sure. This is an unwanted distraction for Sprint
as it belatedly embarks on a massive technology upgrade known as
Network Vision. The company is in the process of ditching all of
its past losing technology moves (such as acquiring the Nextel
push-to-talk network that is now down to 5 million users, or the
Clearwire (Nasdaq: CLWR) debacle that continues to play out) and
aims to establish a national high-speed network on
with industry leader
. Even that effort will require another $1 billion or so that the
company doesn't currently have. (Sprint hopes to secure "vendor
financing," which entails low upfront prices for base stations,
chips, etc. and payment streams down the road.)
That's why Sprint need to settle this lawsuit problem, perhaps
agreeing to pay 20, 30 or 40 cents on the dollar. New York, for its
part, might simply take that deal rather than end up in a very
protracted lawsuit that only enriches the lawyers.
This isn't to dismiss the seriousness of this problem, nor is it to
suggest that Sprint will escape unscathed. But it's a risky gambit
for short-sellers, who might get caught up in a sudden
that forces a big chunk of those 139 million shares to be bought
What could go wrong for the short-sellers and right for Sprint (and
you if you decide to buy shares)? Well, four factors could trigger
a furious short squeeze...
. If the
rises higher from here,
, which now constitutes the majority of all stock market
, buys stocks indiscriminately and the rising-tides-lifts-all-boats
action tends to make short sellers cover, even if they know their
investment thesis is correct.
Second, even a rumor that the company and New York State will seek
some sort of settlement will quickly eliminate short-sellers' hopes
that Sprint will end up on the hook for billions.
Third, signs are emerging that industry
will accelerate this year. In the past few days, both
and Leap Wireless have been bid up on rumors that Deutsche Telekom
is in search of a partner to beef up its lagging T-Mobile unit.
, Dan Hesse, who has inspired the ire of many investors, would
probably like nothing more than to enter into those discussions
with these other industry
. Yes, this lawsuit is an impediment for a deal, but the company's
current market valuation would be quite tempting to a potential
Fourth, Sprint's recent quarterly results showed clear signs of a
company getting healthier, most notably in the area of average
revenue per user and further solid numbers in the second quarter
may just be too much for short-sellers tobear .
The leading wireless carriers, including Sprint, have begun to
sharply reduce smartphone subsidies to improve their
margins. Asking consumers to effectively extend the usable life of
their existing phones should start benefiting the wireless service
providers' margins as soon as the current quarter.
Where are the analysts?
analysts have been largely silent on this contentious issue. I ran
through the recent research from a dozen different investment firms
that follow Sprint, and only Guggenheim Securities bothered even to
analyze the issue. And a week after the lawsuit was filed, Sprint
held a quarterly conference
with analysts, and not a single mention of the issue appeared in
the call transcript. It's as if this potentially major lawsuit
never happened. Short sellers on the call must have been apoplectic
as they sat through a series of "Hi, how you doing buddy" comments
from management and the sell-side analysts.
Risks to Consider:
This is a hugely risky stock. Sprint not only needs to secure
an agreement with New York State, but also get nationwide
indemnification from suits from other states.
Action to Take -->
By placing such a huge negative bet on Sprint, short-sellers are
running the risk of fueling a stock melt-up if some short-covering
leads to a tsunami of
. With such a huge short position in place, it's unwise to pile on
the short side at this point. The risks of a massive short squeeze
are just too great. If you want to play the
long angle for this $2.50 stock (and sell-side analysts value
Sprint at $4 to $6 a share on the basis of comparable industry
metrics), then dig into the lawsuit issues and be prepared to buy
as soon as it appears as if Sprint will devise a face-saving
solution out of its legal morass.
-- David Sterman
David Sterman does not personally hold positions in any
securities mentioned in this article. StreetAuthority LLC does not
hold positions in any securities mentioned in this article.