Over the past year there have been some phenomenal moves in stocks, which some call high beta names, but which for all intents and purposes can be called "crap" companies (we use the term generically in the fashion it has been previously used by the mainstream media). So Zero Hedge decided to do a more in-depth analysis of just which names have benefited by the unprecedented equity rally, and whether their fundamentals justify the record moves from the stocks' 52 week lows.
In order to do this we looked at two company universes: EBITDA positive and EBITDA negative, all of which have had at least a 150% bounce from 52 week lows. In the EBITDA positive universe we further narrowed it down by companies that have an EBITDA-CapEx(or Free Cash Flow as defined)/Interest Expense ratio less than 1, in other words, companies which, without digging too deep, are unable to satisfy their interest expense from Free Cash Flow alone and thus are forced to use either cash, revolver or working capital to meet debt obligations, and also are based in the US, and are members of the Russell 2000 index. The other EBITDA negative universe basically focused on companies that have not only negative EBITDA but a large (>$20 million) interest expense outlay and >$20 million capital expenditures (both on an LTM basis). Lastly, we sorted the EBITDA + universe by TEV/EBITDA and the EBITDA - universe, sorted by % change from the 52% low.
The results are presented below.
What is immediately obvious is that in the "EBITDA positive" camp there are 12 companies that have a EV/EBITDA metric of over 10x currently, and yet can not meet their debt obligations merely from operations (FCF/Int Expense <1). These 12 companies have on average had a 673% change from their 52 week low. This is mindboggling. We are talking about companies whose equity value has bounced on average over 6x, yet whose EBITDA can not meet interest expense and CapEx! Some of the outliers in this group: Clarient, Newport Corp, Powerwave Technologies, Power-One and Morgans Hotel are in fact trading at higher than 20x EV/EBITDA. Someone must be seeing a lot of growth in these five names which need to use cash, revolver or sell working capital in order to avoid filing at some point in the future.
Even more shocking is looking at the "EBITDA negative" companies. Of the 19 companies, if LTM trends are any indication, 9 will have no cash in less than one year! This calculation assumes cash burn is satisfied not only by cash and cash equivalents but also by unused revolver borrowings. One can be positive that the banks, once they see their borrower is starting to go "into the red" will promptly make borrowing on a revolver prohibitively difficult. More shockingly, the EBITDA negative group has a cash burn rate that will deplete all available (excluding working capital) cash in 9.8 months! To say that these companies are viable is practically insane. Biotech analysts will immediately realize the business model: major cash burn with frequent and recurring dilutions in order to raise more and more cash to allow the company to survive. Yet of the 19 companies in this list, there are only 4 biotechs (Human Genome, Cell Therapeutics, Molecular Insight Pharma and Incyte). The "cash burn" model has gone pandemic. And yet, this universe of 19 companies has an average 1,109% outperformance from its 52 week low. This is pure speculative dot com mania, with no basis whatsoever in fundamentals. Amusingly, one of the companies is Goldman Sachs darling and most recent equity follow on offering candidate Palm, Inc. Does a pattern emerge here?
Yes, and the pattern is all about the short interest as a % of float, which is at an astronomic 15.16% for the EBITDA negative companies, and 8.26% for the EBITDA positive list. In addition to the stock loan custodians pulling shorts massively across the board, nank after bank has used its repo desks to recall shorts, thus making both of these universes skyrocket. The goal: issue round after round of equity dilution in order to fund the upcoming capital shortfall. With fundamentals no reason whatsoever to buy into the stocks, the only thing that has driven the stock prices so much higher has been the artificially induced short squeeze. And if the banks pocket hundreds of millions in underwriting fees doing this, so much the better.
So what is the growth trajectory here in the absence of EBITDA growth: keep cutting CapEx (i.e. declining future revenues), reducing net working capital (selling assets) and hopefully reducing debt (through equity offerings). By purchasing follow on equity offerings, investors are buying shadows of these companies, which are now caught in a liquidity conservation mode. As always the key question: where will revenue growth come from remains unanswered?
We plead readers to go through this list and to be very cautious of the names listed here, which are merely the tip of the iceberg. The same concept applies to hundreds if not thousands of companies. That these companies have ramped the way they have is begging regulatory intervention, yet the SEC will of course not lift its little finger to do anything here (at best it may lift its middle finger and wave it in the face of retail investors once this bubble collapses and all these stocks come crashing down). While our methodology has been more a back of the envelope rational approach, we are well aware that there may be unique circumstances for one or more companies that in fact allow it to below on this prestigious list of huge S&P outperformerns. Yet we have our doubts that there is anything secular about these companies, which are merely benefiting from a cyclical short squeeze bounce compliments of an unprecedented bear market rally.
As always, caveat emptor.