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, I noted that "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:
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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.