Research Notes: Shitcos Revisited
2021 is back, baby!
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It was a play on the SaaS “Rule of 40”, the idea that revenue growth on a percentage basis plus EBITDA margin should be greater than 401.
The model here was the inverse of 1-year performance plus short interest, and our list included only companies with a market cap over $300 million and short interest of at least 15% of the float.
In retrospect, it’s not terribly surprising that the market bottomed just two weeks later, for two reasons. First, that kind of snarky, schadenfruede-laden commentary is precisely what happens around a short-term bottom. More seriously, the extent to which short sellers were pressing their bets served as a potential contrarian indicator.
Even in that context, however, the rally since has been extraordinary. Here are the top 8 shitcos as of 6/2, with their score in parentheses and their gains since in percentage terms (as of Tuesday’s close):
Carvana (CVNA) (125): 82%
Beyond Meat (BYND) (121): 31%
Heron Therapeutics (HRTX) (113): 68%
Wayfair (W) (113): 13%
FuboTV (FUBO) (113): 81%
Lordstown Motors (RIDE) (112): 37%
Skillz (SKLZ) (112): 10%
Lemonade (LMND) (110): 42%
The average return of these eight stocks has been 45%. Over the same stretch, the S&P 500 has gained 3%, and the Russell 2000 6.5%.
But even that doesn’t tell the entire story. All of the gains, and then some, have come over the past month. During that time, the average return for these eight stocks has been seventy-three freaking percent:
The sudden resurgence of the “short squeeze trade” definitely is at play here. Bed Bath & Beyond (BBBY) was tied for 18th on our list: it’s more than quadrupled in the past month (and was “squeezing” again on Wednesday before Ryan Cohen rug-pulled the bulls). Invitae (NVTA) gained 277% in a single session after earnings last week (spoiler alert: earnings weren’t quite that good). FUBO gained 45% on Tuesday: that rally actually appears to have been interrupted by the company’s Investor Day presentation (more later). Amyris (AMRS) looks to have received the “meme” treatment as well.
But as the chart above shows, many of these speculative, heavily-shorted names have posted more consistent rallies. Those rallies don’t necessarily seem to have relied on momentum generated by traders on Reddit/WallStreetBets/social media.2
Indeed, our original list had 31 stocks with a score of 100 or higher. The mean one-month return for the group is 51%. 27 of the 31 stocks — again, 31 of what short sellers thought were the weakest stocks out there two and a half months ago — are positive.3 BBBY, FUBO, CVNA, and AMRS skew the average — but the median name in the group (Workhorse Group (WKHS)) is up 40%. Two-thirds are +26% or better.
It’s not just these names, either. We’ve covered the plunge in de-SPACs on this site a few times so far. Since June 30, the last time we checked in, the nearly 300 names in our universe4 on average have rallied close to 20%.
Are We Doing This Again?
What lessons can we draw from this?
The first answer, quite honestly, is who knows? It’s all guesswork at this point. The resilience of the meme rally itself is underrated: who would have believed, in February 2021 that 18 months on GameStop (GME) still would be at $164 (adjusted for this year’s stock split)? Some investors may remember Koss (KOSS), the micro-cap microphone manufacturer that for some reason joined the January 2021 meme frenzy; it still trades at almost 100x earnings, and has nearly tripled from where it traded at the beginning of 2021.
To see that meme rally surge again is truly a surprise. Our view — and it clearly was wrong from a short- to mid-term perspective — was that the spring correction was a sign of excess flushing from the system, and a sign that valuations mattered again. At the least, it did feel like the market, like the rest of society, was headed for a return to normalcy after a crazy two-year ride. That is not yet the case.
But a second conclusion has to be drawn from the fact that this rally is not just meme stocks. Again, we’re seeing huge relative and broad-based strength in speculative names of all kinds. And so the data seems to argue for a positioning-based rebound since May. That in turn suggests that a quant-driven “long volatility” strategy, along with the desire for investors of all stripes to recapture losses, is at play.
A few investors of late have posted on Twitter that this is a disorienting market. It’s difficult to disagree. There probably will be a time to try and bet against this renewed round of insanity. That time may be soon, and the rally of late has presented no shortage of tempting short targets (at least in theory).
But as we discussed at length in our short call on Carvana (the one we got right, incidentally), there’s no need to try and time the top.
The Updated Shitco Rule Of 100 List
In the meantime it’s worth revisiting our little index, to gain broader understanding and to look for potential opportunities. Here’s the top 25 (data comes from finviz.com):
Upstart (UPST) / 119
Carvana / 114
Cassava Sciences (SAVA) / 113
Cazoo (CZOO) / 111
FuboTV / 108
MSP Recovery (MSPR) / 108
Astra Space (ASTR) / 106
Porch (PRCH) / 106
Invitae (NVTA) / 105
Novavax (NVAX) / 104
Beyond Meat (BYND) / 104
Olo (OLO) / 104
Wayfair / 103
GoodRX (GDRX) / 102
Zymeworks (ZYME) / 101
Skillz (SKLZ) / 101
Stitch Fix (SFIX) / 100
Reata Pharmaceuticals (RETA) / 98
Editas Medicine (EDIT) / 96
Virgin Galactic (SPCE) / 96
Cardlytics (CDLX) / 96
Amyris (AMRS) / 95
SpringWorks Therapeutics (SWTX) / 90
Heron Therapeutics (HRTX) / 89
Big Lots (BIG) / 88
Notably, there are fewer names on the list with a 'score' above 100. Only 17 compared to 31 in June5. And there are fewer outside of biotech/pharma (typically a sector where short-sellers target broken stories); nine of the 25 are in that space.
But, again, if the current trend holds, there should be winners in this group. And so it’s worth taking a look at the non-biotech names to see if there might be either long-term value and/or a short-term catalyst presuming the “long vol” strategy continues to work.
A month ago, we accurately predicted that UPST would top this updated list.
It’s not hard to see why. By any measure, the Upstart story seems to have broken. The narrative here was that artificial intelligence made Upstart a better lender. With each quarter that goes by, that narrative seems weaker and weaker, as we wrote after the company pre-released soft Q2 numbers in July.
If anything, the story looks worse now after truly ugly guidance for the third quarter. And on Twitter, Siyu Li highlighted an intriguing passage from the Q2 conference call:
In the piece linked to above, I compared Upstart to Enova International (ENVA), a subprime lender that historically has traded at heavily compressed multiples. One of the advantages Enova has long cited has been its huge trove of data, yet that alone hasn’t convinced investors to pay up for what’s been pretty solid financial performance over time.
If Upstart is saying that it doesn’t have that same data, and it now can’t expand into new markets because it’s funding loans on its balance sheet, and it can’t turn a profit even with credit card delinquencies at the lows … Let’s just say the burden of proof remains heavily on the company and on UPST bulls to show what, exactly, the long-term value proposition is.
It’s a tough market to short in, and heavy short interest here is a large obstacle. Indeed, UPST is up almost 40% since we expressed our skepticism last month. But that short interest itself reflects the market’s reaction to the past few quarters as a sign that this story simply is not what management has said it is:
At this point, management is going to have to prove the market wrong. I’m skeptical that it will. At some point — perhaps ahead of the Q3 report — I’d be interested to take the other side.
There are a lot of names like CZOO out there right now, particularly in the de-SPAC world. A lot of investors are going to go broke chasing the wrong ones. A few will make big returns picking the right ones.
The United Kingdom’s version of Carvana — even Bloomberg has called it a “copycat” — is hemorrhaging cash just like its US counterpart. Shares are down 90%-plus from per-merger highs. Cazoo also has $630 million in convertible debt which is an obvious anchor (and may explain, at least partially, the still-high short interest below $1, both in terms of the “short to zero” case and long debt/short equity trades).
That said, Cazoo is still growing. Revenue increased 145% year-over-year in Q2, and 153% in the first half. Shares more than doubled after the earnings release earlier this month, though they’ve since retreated. There’s still a reasonable amount of cash on the balance sheet along with self-financed inventory. The company likely will exit EU markets, which limits upside but should also mitigate cash burn. The same is true of marketing expense: Cazoo spent lavishly on sports sponsorships to the point that 2021 marketing spend incredibly was £1,300 ($1,788 at last year’s average USD/GBP) per car sold.
This is a company that might be able to survive for longer than current cash and cash burn figures suggest. And in this market, survival plus a higher short interest plus a share price below $1 (it’s cheap!) plus volatility creates an intriguing trade.
Fundamentally, there’s one huge problem, admittedly. Cazoo’s first-half gross profit dollars were £3 million, or ~0.5% of revenue. The same criticism of Carvana — that it’s easy to grow selling $1.00 in value for $0.95 — certainly applies here. The most likely outcome is that CZOO hits zero.
But in this market, the question isn’t necessarily when or even if CZOO hits zero. It’s what happens on the way there.
We’ll likely have more to say on FUBO in the not-too-distant future. Suffice it to say that even after the company’s Investor Day, there’s little evidence that this business model — which seemed flawed from the outset — actually works. With the sports betting opportunity clearly a dead end, this too looks like a business trying to sell dollars at a discount. The core lack of scale — because the primary cost, affiliate fees to networks, occurs on a per-subscriber basis — doesn’t seem to have a workaround.
But this was fun:
At Wednesday’s close, the stock is now down one-third from the intraday peak. Maybe you can short stocks after all.
Olo provides a cloud-based suite of solutions for restaurant chains. It’s an interesting business — but valuation has been a question mark since last year’s IPO. At August highs of $45, Olo had a market cap around $7 billion, in the range of 50x revenue.
The stock is down 80%-plus since, including a 36% sell-off after a soft Q2 release last week. And what’s interesting is that OLO now looks an awful lot like a spring 2022 stock.
Yes, the declines are big. But the stock hardly seems cheap. Based on 2022 guidance, shares still trade at more than 7x revenue. That’s with full-year guidance implying ~23% growth, including a deceleration in the second half.
Olo is guiding for an adjusted operating profit this year, but as with so many tech stocks stock-based comp is the reason why: adjusted EBIT guidance of ~$8 million compares against a first-half run-rate for stock-based comp of $46 million.
It was stocks like OLO that led me personally to believe we wouldn’t see this kind of rebound. What I missed, however, is that it’s been the other stocks — the ones with worse businesses — that have led the way.
As of this writing, Vince Martin has no positions in any securities mentioned.
Tickers mentioned: UPST OLO CZOO FUBO BBBY CVNA AMRS
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EBITDA margin in this rough model can be negative, as long as the business is growing the top line 40%-plus.
Or, for the more conspiratorial-minded, hedge funds using retail investors as cover. I have no evidence, but little doubt, that’s taken place as well.
Condolences to any readers long Virgin Galactic (SPCE), Arrival (ARVL), Up Fintech (TIGR) or Eros Media World (EMWP).
We originally highlighted the 291 mergers that closed between 1/1/20 and 4/6/22. The list now includes a few acquisitions plus, by my count, three bankruptcies.
Yes, we know this is a little silly. What else are you supposed to do in this market? Deep-dive fundamental analysis? Do you want to look smart or make money?