Boston, Sept. 21 (Bloomberg) -- Two investors tied for first place in this column's first annual Short Sellers Don't Have Horns contest.
Short sellers bet on stocks to decline. They borrow stock, sell it, and immediately get a credit in their brokerage account for the proceeds. At some point, unless the stock goes to zero, they must buy shares to replace the borrowed ones. If the price falls before they buy the replacement shares, they profit.
The contest winners -- Greg Margolis, an analyst at Glickenhaus & Co. in New York, and Glenn Skreppen, a securities- lending trader at Mellon Bank Corp. in Pittsburgh -- each hypothetically sold short LHS Group Inc., an Atlanta maker of billing systems for telephone companies.
LHS shares fell 39 percent during the contest period, which ran from Sept. 15, 1998 through Sept. 15, 1999. That gave each of the investors a 39 percent profit.
For their skill in spotting short-sale candidates, Margolis and Skreppen will each receive a biography of Napoleon (a famous short person).
LHS Group's Woes
The second annual Short Sellers Don't Have Horns contest begins Sept. 30. The contest rules appear later in this column.
During the past year, LHS has been controversial for at least three reasons. Its receivables have been high. The way it accounts for its receivables has been disputed. And it fired its chief legal officer, Wolf J. Gaede, in April, saying he had made ``damaging'' statements that hurt the company.
A 39 percent gain may not sound like a huge profit, but it was a tough year for short selling. Most contestants suffered losses as their ``overvalued'' stocks soared.
Manuel Asensio, a professional short seller, took second place with a 29 percent gain on his short sale of Lyondell Chemical Co. of Houston. Asensio is president of Asensio & Co. in New York. He figured that Lyondell had a problem because it borrowed $6.5 billion last year to acquire Arco Chemical Co. Asensio estimated that the value of Arco had fallen substantially by last September. Meanwhile, the terms of Lyondell's loan agreement with its banks required Lyondell to sell more stock, which Asensio anticipated would dilute the value of existing shares.
Third Place Tie
As it turned out, Lyondell renegotiated its financing, selling less stock than originally anticipated but taking on more debt. As of June 30, the company had more than $5 in debt for every dollar of stockholders' equity. Lyondell also was hurt by the rising cost of raw materials, such as petroleum.
Third place in the contest was a tie between Mike Ruggiero and David L. Swartz. Ruggiero is another securities lending trader at Mellon Bank and sits next to Skreppen. Swartz is an analyst at Presidio Management, a San Francisco firm that runs private investment partnerships. They both shorted Lernout & Hauspie Speech Products NV, a Belgian company that makes speech recognition software. Its shares fell 26 percent in the contest period.
I allowed Lernout & Hauspie into the 1998-99 contest because my instructions last year were a little unclear. I specified that an entry must concern a ``U.S. stock,'' but didn't define the term. The company is traded in the U.S. but isn't U.S. based.
Priced Too High?
Lernout & Hauspie shares were depressed by a controversy concerning its investment in a privately held Houston start-up called e-DOCS.net. The shares were also hurt by a revelation late last year that the Securities and Exchange Commission was investigating the way Lernout & Hauspie accounted for acquisitions.
There is no prize for second or third place except fame.
Experienced short sellers often warn against selling a stock short simply because its price seems too high. The seller should also have some specific nugget of knowledge that he or she figures is likely make the stock tumble -- and that isn't already widely recognized.
Shorting stocks based on high price alone proved a disastrous strategy in the contest. The majority of contestants suffered losses as their stocks uncooperatively rose instead of falling. The unsuccessful shorts included many whose prices seemed wildly high to the contestants -- and to me.
For example, several people picked Amazon.com Inc. to decline because it was selling at what appeared to be bloated multiples of sales and book value. The only reason it wasn't selling for a bloated multiple of earnings was that it didn't have any earnings.
Losses Widened
No matter. Investors' tidal wave of enthusiasm for the Internet in general and Amazon.com in particular enabled the stock to quadruple. Today Amazon.com shares sell for 37 times book value (corporate net worth per share) and 21 times revenue. The company still hasn't produced earnings; in fact, its losses have widened.
My own pick, Metromedia Fiber Network Inc. was the same story. The White Plains, New York-based company, which develops fiber-optic networks in North American and European cities, continued to lose money but the stock soared fourfold. Metromedia Fiber shares are now at 32 times book value and 69 times revenue.
This year, the contest will run from the close of trading Sept. 30 through the close on Sept. 15, 2000. To enter, you must e-mail me by midnight Sept. 30 at jdorfman@bloomberg.net. Name the stock you think is likely to go down the most for that 11-1/2 month period. It must be a common stock of a U.S.-based company, trading on a U.S. exchange. The market value must exceed $500 million as of Sept. 30, 1999.
A Surprise Prize
Please include your name, city, occupation, e-mail address and phone number, as well as the name and symbol of the stock you are shorting and a brief statement of the reason you expect it to decline.
As was the case last year, there will be a prize, but the nature of the prize will be secret until the contest is over.
This is a theoretical contest in that you don't have to have real money at stake. It doesn't matter whether you can actually borrow the stock to sell it short. Also, the contest disregards commissions and borrowing costs.
If two people pick the same stock, I will award the prize to the person I like better. (See, your mama always told you that short-selling was a nasty business.) If more than one entry goes to zero, the one that loses all its value the fastest is the "winner."
Sep/21/1999 20:14
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