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Nautilus Inc. Message Board

  • drumnbasssmartass drumnbasssmartass Nov 4, 2003 11:18 PM Flag

    Why the Short Story Confuses Me

    I remain perplexed by certain traders unyielding committment to shorting NLS.

    I just finished reading an article that identified a half a dozen (out of 1,000s) of candidates that are due to blow up:

    Akami, Rambus witha P/W of 110, Xybernaut, which continues to bleed red ink, RIMM, which has a P/E of 232, Pumatech, which is UP 1,719% with no calculable P/E....and still shorts opt to play NLS?


    Certainly NLS' future is debatable, and I can see both sides of the argument...but their numbers are still fundamentally sound...yet the market plays Goofs like the aforementioned tech stocks....and you shorts are still here...there's got to be an easier play somewhere else...

    Any comments on WHY welcome....

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    • <<Pumatech, which is UP 1,719% with no calculable P/E....and still shorts opt to play NLS?>>

      Shorts are much more afraid of a stock that can go up 1,719% than of a stock like NLS.

      There a few things to understand about shorting. First, despite numerous myths to the contrary, margin cost is zero. In fact, short sales produce POSITIVE cash flow. If you think about this it makes perfect sense. The short borrows no money, only shares. He sells the shares for cash. The cash goes into an escrow account which throws off interest. A sliver of that interest (20-50bpp) goes to the share lender as an incentive fee. The rest goes to the short seller. It's called a short rebate. Brokerages confiscate the short rebate from retail customers, of course, because we're weak and can't do anything about it. Same way with the share lending fee - E*Trade will lend your shares out at the drop of a hat and never pay you a dime. But institutions have enough clout to capture these cash flow streams.

      So a short can make money on a stock even if it never goes down. Of course he locks up margin capacity, so there's an opportunity cost. And at today's rates the short rebate barely covers the lunch bill. But there's still no out of pocket expense as many (e.g. astral_tsar) seem to believe.

      But what about dividends? Well, that IS an out of pocket expense. Shorts always think twice before shorting a dividend payer. But if the short is confident a business is a loser then it doesn't really matter if they pay a dividend or not. Let's say company X has $10/share in cash and perpetually loses $1/share each year. For some reason it trades at $20, an excellent short candidate. Does the short care if this company announces a $1/share annual dividend? Not really, it just means they'll run out of cash in 5 years instead of 10. He'll be out of pocket $5 during the holding period, but $15 net profit in 5 years beats $20 over 10 years.

      There's also the tax angle. Someone who shorted NLS at $35 originally had to lock up 17.50 in margin capacity. But as NLS declined his situation improved. With NLS at $15 he's only got 7.50 of margin capacity tied up. Much more importantly, he has $20 in his pocket TAX FREE! Well, tax deferred to be precise. He can invest the $20 elsewhere or even spend it. If he covers the short, however, he now has to pay income taxes on the $20. And short sales are always taxed as short term capital gains. so he might easily owe $8/share to federal and state governments. But if he keeps the short position open and invests the government's $8 in high quality REITs paying 7% it produces 0.56 in dividends. That covers NLS's 0.40 payout and leaves him 0.16/share to spend on Armani suits and weekend jaunts to the Bahamas.

      In summary, the shorts don't necessarily need to be 100% certain NLS is going down. They just need to feel confident it's not going up.

      • 2 Replies to doggydogworld
      • Ok, since a couple of poor souls recommended doggydogworld's tricky but misleading post, I'll clarify why it's off-base.

        1. The comment about shorting "throwing off positive cash flow" is a red herring. (Even if you consider your escrow account "cash", which is a stretch.)

        Borrowing on margin ALWAYS "throws off positive cash flow." (I.e., you get cash.) That's the whole point of borrowing. But loans cost interest, regardless of whether they're denominated in cash or in shares.

        Sorry, but you ain't gonna make any net income just by clicking on the "borrow" and "lend" buttons on your browser. No, not even if you get tricky and borrow "shares, not money." They THOUGHT of that already, ok?

        This one really only works if the share price drops (surprise!), *releasing* cash from escrow. Share price is up 50% since July, so shorts' cash flow is negative (to put it mildly). Let's move on.

        2. doggydog assumes that -- on balance --institutions are short and individual shareholders long. For a profitable dividend-payer in a bull market with 28% of the float short, that's possible but very unlikely.

        3. doggydog gives an example of a company that's losing money AND paying dividends. Wrong board. NLS ain't losing money. It is earning in the vicinity of 3x the dividend payout. (Thanks shorties!) So by doggydogworld's own argument, something like 2x dividends are added to share value every year. Good luck replacing the shares cheap.

        doggydogworld -- thanks for that carefully misleading mosaic of facts and near-facts. I don't see a lot of quality disinformation on the board anymore -- your post almost reminds me of the good old days when technically_speaking was basher-in-chief for NLS. But he left around $11 or $12 on the way down ... go figure!

      • Very long post. Lemme sum it up:

        Yes, shorts pay dividends and interest. Yes, institutional share lenders get full interest for lending out their shares. No, despite appearances, your margin doesn't belong to you until you replace the shares. Yes, paying interest & dividends to short a healthy company at value prices in a bull market is financial suicide.

        But shorting other things at other times can be a great move.

        And I agree.
        But see how simple the message becomes when I boil it down, doggydogworld?

    • The most likely rationale to justified a large shorts position is the perceive imminence of the fading Bowflex sales and the heavy reliance of NLS performance on Bowflex. The decline of Bowflex sales has been anticipated for quite a long time, rj2gordon being a good example of this school of though.. As early as 2001 short positions represented 23 days to cover. Posters suggesting a debacle similar to the Nordic Track demise showed up as early as 1996. Late last year signs of a decline in sales started to show up resulting in a serious stock price correction. Fortunately NLS management stopped the bleeding of the direct sale by embracing the retail market. This will further postpone the fade theory. To estimate by how much time, lets use the information already available.

      So far Bowflex sales are around one Million units. According to a recent study sponsored by NLS, 80% of the targeted consumers purchase fitness equipment through retail. Assuming a similar penetration of the direct channel one can calculate a potential of 4 Million Units for the retail channel. Of course the environment and the competition level are drastically different at the retail sector and one should decrease this number. Even if you select a Million units one can see that in the next three years a decline in sale is unlikely. At its peak Bowflex sales reached about 57K units in a quarter. Last quarter 49K units were sold(29K direct and 20K retail). With the continue growth at the retail sector(157% last quarter) Bowflex sales will probably reach new sale level at the end of this quarter.

      One can also anticipate the potential of the TreadClimber. Cardiovascular market represents over 70% of the dollar spent on exercise equipment. Assuming a similar success than Bowflex one can estimate 2 Million Units for the direct channel.

      There is no confusion, these numbers clearly suggest a bright future for sales, whether the company will deliver sales in earnings is the true question.

    • I have only the conventional wisdom, for what it's worth.

      Ask yourself this: Who benefits? Why might analysts' bosses and journalists' bosses be happy to see heavy shorting of a solid business? The usual "why" for those bosses is that they want to please large institutions.

      Lending shares to shorts can be a great move. The institutions can bargain with their brokers to get good interest payments on the borrowed shares, and the institutions still get their dividends. For NLS, this total might roughly triple the dividend for institutional holders who allow their shares to be lent out.

      So why is incautious shorting being touted for solid companies at bargain prices, BUT not for overpriced pieces of crap? Because the folks who benefit have to buy and hold the stock without getting burned. None of the above works if the underlying business falls apart!

      In previous messages I've already pointed out the extra benefits for institutional shareholders if the short interest remains imprudently high. But that's just gravy.

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