The only way to make money by shorting a stock is to find potential land mines many investors may be missing. For wireless services provider Sprint (NYSE: S), short sellers have been focusing on two items: a looming legal battle with New York State's Attorney General Eric T. Schneiderman, and a debt-laden balance sheet that would be unable to support the company's ambitious capital-spending program.
Yet as I noted a month ago, short-sellers have been looking quite vulnerable, as their most dire concerns may not come to pass. Shares have risen 25% since then, and I see similar upside -- past the $4 mark -- in the months ahead.
If I'm right, that would be a quick gain of about 30%.
The squeeze potential remains
Since that short interest data was released, a pair of events has emerged that should have these short-sellers pondering a move to cover their short positions and those who want to buy this stock seeing green.
First, Sprint has asked a judge to dismiss the lawsuit that was brought by Schneiderman for supposedly failing to pay sales taxes for the past seven years. The company claims the attorney general has fundamentally misread the statutes regarding sales taxes. Sprint claims the revenue it did not collect taxes on are nontaxable, because they reflect interstate transactions.
I still don't know how this process will play out, but the odds are rising that either Sprint will agree to a settlement at a lower amount than short-sellers may be anticipating, or that Sprint will prevail outright. This is a fluid situation, so it bears close monitoring if you own this stock.
The second factor: Short sellers have suggested that Sprint lacks the funds to complete its Network Vision program, a high-tech network designed to enhance the voice quality and data speeds for customers in the United States. As I wrote a month ago: "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.)"
Well, at a series of investment meetings held in London in early June, Sprint noted that vendors are playing ball. Ericsson, for example, will provide up to $1 billion in upfront subsidies for equipment purchases by Sprint. "Sprint considers itself 'fully funded' for the whole of its Network Vision plan," Merrill Lynch's analysts note, adding that with this risk reduced, they see shares rising up to $4.50.
If they're right, then we're talking about a 50% gain.
There's even a third potential catalyst that could lead short sellers to cover their positions and send this stock even higher. Sprint recently announced plans to offer the next iPhone without any subsidies to consumers who want to pay up higher upfront prices for a phone in exchange for lower monthly bills. Analysts at Guggenheim Securities say this could enable Sprint to sell more than a million iPhones a year, making the carrier a relevant player in the Apple (Nasdaq: AAPL) ecosystem.
Analysts at Citigroup are perhaps the most bullish of all, deploying a $6 price target, or nearly 100% upside from current levels. They come up with that target by triangulating discounted cash flows, price-to-free-cash flow and enterprise value to EBITDA. They note that Sprint has "shown significant (operational) improvement over the last two years." They add that margins will likely rise steadily higher once the company's Network Vision upgrade is complete.
Risks to Consider: If the U.S. economy slips into recession, then consumers will increasingly gravitate toward lower-cost pricing plans that yield smaller margins for Sprint and its rivals. Also, the New York state lawsuit will need to be settled or dismissed before this stock can post further gains.
Action to Take --> Sprint isn't quite the picture of health just yet: Verizon (NYSE: VZ) is clearly still a superior operator. But Sprint appears to be making the right moves to eventually boost its reputation among consumers and its market share in this highly competitive business. Short sellers have been focusing on a troubled company, but they need to update that view. And investors who are willing to bet against them could win big.