Short selling is not for the faint of heart. If you get it wrong, then you could lose a lot of money quite quickly. That's because a heavy short interest can lead to a short squeeze that adds unwitting buying pressure. And this may be precisely what happened to wireless services provider Sprint (NYSE: S).
Back in mid-May, "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 to bear."
Well, that has indeed been the case, and this stock is now up roughly 60% since then. Remarkably, the short sellers appear not to have seen it coming. As of July 13, the short position had risen to 176 million shares, up from 139 million when I looked at this stock in May. Presumably, some of those shorts sought to cover their bad bets when solid second-quarter results came out on July 26. But the short sellers that are standing firm may be in for more pain, as this stock could rise to $6 (or another 50% from here).
In short, this company is morphing from being a clear industry laggard to one that is beginning to deliver operating metrics in line with the industry's top players. Management, which had laid out lofty plans to upgrade the company's network, has thus far delivered on its goals: shut down the disappointing Nextel network on a timely basis, boost the amount that subscriber's pay, and reduce monthly churn.
A quick look at second-quarter numbers tells the story:
It's that last point short sellers need to think about. Many had assumed Sprint would face some sort of liquidity crunch to meet its Capex needs, leading to possible painful dilution for shareholders. Now, it no longer appears to be the case.
To be sure, Sprint will need to come up with $1.35 billion in 2014 to pay off bonds that are coming due, but the company's financial picture is getting strong enough to enable Sprint to issue new bonds to cover that debt. Moreover, improving fiscal health implies that Sprint's cost of capital could drop, meaning the company will be able to replace high-price debt with lower-cost debt as time progresses.
A settlement still in the works…
What about that $100 million tax fraud lawsuit with the state of New York I discussed in May? Well, the company had nothing to say in its prepared comments on the conference call, nor did any analysts bring up the topic. Presumably, talks continue, and this still stands out as a risk for the stock, should any legal ruling prove onerous.
Analysts, many of which had been cool to Sprint, havebeen warming up to the stock: Citigroup was already a fan, and maintains a $6 price target; Analysts at UBS hiked their price target from $2.50 to $6, noting thanks to a "significant increase in our outlook for EBITDA and FCF over the next 3 years." Analysts at JP Morgan also went to a $6 price target (from an undisclosed prior target), citing the fact that "Network Vision is progressing on schedule and management expects ~$300m less dilution in 2012 adj. EBITDA vs. the $1.1b Oct. 2011 guidance." And analysts at Credit Suisse reiterated a $6 price target, predicting that Sprint will likely generate $8 billion by 2014.
All of these analysts have the same price target, which may be a serious case of groupthink. But each arrives at that target using different methodology, which should give existing short sellers something more to think about.
Risks to Consider: A short squeeze may have helped to fuel big gains this week, and if that process is complete for now, then shares may pull back a bit in the next few trading sessions as long-oriented investors book profits. Also, the outcome of the lawsuit still stands out as a risk for the stock, as I said earlier.
Action to Take --> Sprint is in a clear transition from poorly run to well run. The company's key financial metrics are good and improving. Few would have predicted that from this perennial laggard a few years ago. Credit goes to CEO Dan Hesse, who took ample abuse when Sprint was struggling but is now in contention for "comeback CEO of the year." As investors reframe their view, shares should keep appreciating.