Yesterday I wrote to you about a newsletter that was calling for a short squeeze on a little Chinese stock, and today we’re again looking on the short side — though this time, it’s a short pick from Dan Amoss, who thinks he’s got the next NASDAQ stock that’s “headed straight for a body bag.”
Amoss had a lot of fans for his Strategic Short Report when the market crashed and so many stocks went down in flames, as you might expect for a short-biased newsletter, and, as you could also probably predict, that sentiment turned around when his short bias kept folks out of the rally of the last two years, or had them betting against stocks that actually did well. All that sentiment is reflected in the reviews submitted to Stock Gumshoe Reviews, where Strategic Short Report was one of the top-ranked letters for a few months in early 2009 … you can just check the dates of those comments and it will all make perfect sense, it’s kind of like looking at the reviews of any of the more general long-biased market newsletters in reverse.
The last time I wrote about an Amoss short pick, I think, was back in the Summer of 2009 — he had a very aggressive promo going out that teased us about the “next bank stock to crash”, and at the time that kind of language naturally got a lot of attention … it fired up all the discussion boards and got everyone freaked out about the dividend cut he expected from Bank of Montreal (BMO) and the subsequent expected collapse in the share price, and even made it into Bloomberg (along with yours truly). Except, as history now tells us, he was dead wrong — BMO was not as weak as the US banks, did not cut its dividend in any significant way, and the share price didn’t ever have a major drop after that teaser ad.
He also claims credit on several picks that did work out, of course, like Lehman Brothers, it’s just that those picks weren’t aggressively teased, or at least I didn’t see ’em at the time. I don’t have any reason to doubt that he’s had some good picks, but I don’t know what his long-term track record is … still, I think it’s worth finding out who he thinks this “bodybag” stock will be.
This teaser is, again in the form of a video without a handy text transcript, so I’ll do my best to quote some key clues for you and otherwise share the gist. Here’s what he says:
“On March 15, 2011, one of the market’s hottest fad stocks could take a huge blow, causing its share price to plummet.”
Amoss says that this company ha been lying to shareholders, that it’s a “fly by night company headed to the gutter,” and that you can profit when those lies are exposed if you just “follow the simple step” he’s recommending to his subscribers.
March 15 is cited because that’s the deadline for them to file their annual report.
Another direct quote? Here you go:
“as you’ll see shortly, there’s a dirty secret lurking in this report that could bury their share price and make a few first-movers rich.”
The ad then goes on to tell us that the stock price has gone crazy over the past year, going from a low of two dollars to over $10 in January, “based only on the fad industry in which this company operates.”
He even pulls out the A-1 bogeyman of stupid fad stocks, telling us that this one is “not much different” than the pets.com debacle during the internet boom (though apparently this teased stock hasn’t yet bought a Super Bowl ad).
So what’s the product? We’re told that you can buy it at your local Best Buy, and that it’s also sold at Verizon, AT&T and Sprint stores, and sold at kiosks at the mall.
And then, though it brings a tear to your Gumshoe’s eye, he lets the cat out of the bag. He actually named the ticker, albeit briefly, as he was churning through the presentation — usurping the role we delight in playing here at Stock Gumshoe. Dang.
But still, most people probably won’t sit through that presentation like I did, I expect, or have listened closely enough to realize that the name of the company was unceremoniously revealed. So I’ll still tell you about them and try to explain what Amoss doesn’t, which is exactly how he thinks you can bet on the company’s possible demise — this stock is …
ZAGG Inc. (ZAGG)
The ad tells us that there are several problems with this company that mean the stock is headed for the trash heap: They have a terrible product in a crowded market, they are dependent almost entirely on this product, the CEO and management team have a history of guiding penny stocks into the dumpster, and Amoss says they may be using “Enron-style accounting.”
Amoss cites some Amazon reviews and other complaints to back up his claim that this company’s product, which is basically a screen cover for iPhones and tablet computers (in his words, “Those flimsy plastic screen covers for cell phones and tablet computers”), is garbage, with an unusually large number of terrible one-star and two-star reviews — and he also notes that several other companies sell essentially the same thing for a quarter as much or less.
He also tells us that …
“95% of their revenue comes from this one terrible product”
And that the “fad market” they operate in is “absolutely crammed with competition.”
More controversially, perhaps, Amoss tells us that the CEO of this company had a big stake in six penny stock “pump and dumps” — and that this could be his next penny stock pump and dump scheme.
Amoss mentions a handful of past penny stocks that the CEO or management team were involved with, either as stockholders or something else, and that could have been very profitable for them but have since seen their share prices fall, stocks like World Series of Golf (WSGF, at two cents now after hitting $3 in 2007) and Dreamfly Productions (DFLY, doesn’t seem to exist anymore), among others. I haven’t checked that data, though I have seen it circulating in a power point presentation from an “unnamed hedge fund” in recent months (as with all penny stock short ideas, there is a lot of arguing about this one — an anonymous writer at SeekingAlpha posts frequently about ZAGG and included a link to what he said is the hedge fund’s presentation in this post.
Considering the exact match for the content, I assume Amoss is also referring to this presentation from an unnamed source, though he may well have done further research as well or have gotten the report more directly from the folks who did the background research (I assume this research was presented somewhere — otherwise, why have a powerpoint? — but I don’t know where, nor have I checked any of the claims made in that research).
Amoss also says that he thinks ZAGG may be guilty of “Enron-style accounting” — he suspects they’re booking revenue before they should, claiming profits before a deal is done. He says they’re doing this with Best Buy, which is by far their biggest customer — he thinks they’re booking revenue on Best Buy orders before getting paid for them, and they might not get paid for six months. And Best Buy can send back the orders and not pay at all if demand drops, which could decimate ZAGG’s sales numbers. This issue of revenue recognition and possible inventory problems has also been the source of speculation from the same blogger at Seeking Alpha (“Worthless Pennies” is what he calls himself), who claimed that the change of auditors back in January was a bad sign.
The company, of course, disagrees with these negative comments and arguments — they went so far as to issue a press release response after the first wave of this hit in December, though they didn’t specifically respond to any of the details of the allegations that I saw (not that they’re obligated to do so). More recently, there has been some more “mainstream” concern about the company that has surfaced mostly because Apple is getting into the case/protector business themselves with the new smart cover for their iPad 2, which helps to explain at least some of the recent share price weakness (the stock is down 20% or so from its January highs).
So Amoss is obviously recommending some sort of short position in the stock — in which he would not be alone, according to Yahoo Finance about 35% of the share float is already sold short.
He doesn’t tell us specifically what his recommendation is, but let’s see if we can figure it out. Dan Amoss doesn’t typically recommend short selling — it’s tough for a newsletter to manage because it requires more hand-holding of subscribers, it’s more complicated, it requires special broker permission in many cases, and it also just plain turns people off for some reason. What he usually recommends, as far as I can tell, is buying put options — an options trade that gives you exposure to downward price movement, and would also make it possible, depending on what the stock does, to double or triple your money on these shares.
So I suspect that he’s recommending a simple put buy to his subscribers. If you aren’t familiar with this, a put option is the opposite of the more familiar call option — if you buy a put, it gives you the right (but not the obligation) to sell a specified stock at a specific price before the expiration date of the option and effectively either protect some of your profits in a stock if you own it and are afraid it might fall, or speculate on the fall of a stock.
ZAGG, though it’s a small company at less than $200 million in market cap, does have options trading on the shares — if you think that there will really be a debacle in the stock next week after their annual report is due on March 15 but before next Friday, March 18, there is a March expiration, and there are also expirations available in April and May if you think it will happen soon but maybe not immediately.
And if we look at the open interest in put options on ZAGG, it seems likely that if his newsletter is recommending a specific position, that options contract will probably be relatively widely held (“open interest” is the number of options contracts that currently exist — as opposed to volume, which is the number that have changed hands that day). There is a fair amount of open interest in next week’s options, but the biggest outstanding contract interest is in the $5 and $10 puts for May — meaning, people who are buying (and selling, of course — there are two sides to every trade) the right to sell ZAGG for $5 or $10 per share anytime between now and May 20.
You can generally think of “in the money” options as being less risky and less speculative, since they’re actually worth something right now (ie, the strike price means you could profitably exercise the option), and in exchange the return potential is not quite as high as it would be for a more speculative “out of the money” option, and these two possibilities illustrate that fairly well. Here’s how the options could work:
ZAGG’s share price right now is at about $7.80, so a $10 put option is worth at least $2.20, because if you held that option you could buy the stock at $7.80 on the open market and force your put option contract counterparty to buy it for $10, netting you the $2.20 difference (in practice you’d probably never do this, of course — almost all options are just bought and sold to open or close positions, they are rarely exercised).
The difference between that “at least” value and the actual price of the options contract is often called the “time value” or the “premium” of the option — so in this case, the ZAGG May $10 Put option is currently trading at about $3, so there is about 80 cents of “time value” … that’s the extra that you pay for the right to keep this open-ended option to sell for about two months.
And I’d be willing to bet that this is the contract that Amoss is recommending, since he tells us that we have the opportunity for 200% gains, or a triple of your investment as the stock price collapses … and if he’s right about the collapse and about the timing, if the stock price of ZAGG went to $0 before May 20 (or to a few cents, as the case may be — even the worst ones almost never make it quite to zero). you would indeed be able to just about triple your investment.
As in, you could buy the put contract for $3, and if ZAGG went to, say, 50 cents in share price, your option to sell at $10 would be worth $9.50 — $6.50 in profit from a $3 investment, a return of just over 200% and a triple. And since the option is “in the money” you do fine as long as the share price goes down at least a bit — you wouldn’t triple your money if the stock fell by just 20%, but you would make a profit. Of course, if the stock goes back up to $10 or higher and stays higher, your options contract would likely expire worthless.
The other fairly widely-held option for May is the $5 strike price, which is “out of the money” — meaning that since the stock is above that price now, it has no value at this moment, any value that you assign to it is speculative based on the future movement of the shares. It also costs a lot less, as you would expect, it has been trading lately for about 40 cents.
So your outlay is 40 cents for this one (or $40 per option contract, each contract represents 100 shares), and you need the stock to fall to at least $4.60 to break even. If the share price does really collapse, though, you get more leverage from these “out of the money” options — if the stock, as in our other example, goes from $7.80 to 50 cents in the next two months, your option would suddenly be worth about $4.50. So that’s roughly a 10X return, the fabled “ten bagger.” And in exchange for this kind of outsize leverage, you really do have to have the stock drop dramatically to make any money — if the stock falls just 20%, your option would expire worthless (these examples all assume that you wait to close out the option trade at the expiration date, you could certainly do better or worse if sentiment moved the option prices more quickly than it moves the stock’s share price at any given point in the calendar).
And yes, if you’ve never shorted a stock before, buying put options is certainly a less nerve-wracking way to bet against shares than actual short selling — the downside is known ahead of time, so you don’t get the problem of having to hedge your short position or watch it like a hawk in case something terrible (ie, wonderful for the company) happens … such as, for example, ZAGG invents some fabulous new case and gets the exclusive right to sell it through Wal Mart and the stock quadruples.
If that happens (however unlikely) and you’re short the shares and unhedged, you could lose huge in having to buy back a stock for $40 (for example) that you sold for $7.80 — that’s part of what makes people afraid of short selling, the fact that the upside is limited (there is no number lower than zero as the stock goes down) but the downside is theoretically limitless (the stock could go to $5,000+ a share, theoretically, though you’d have to be an idiot and have a huge margin account to remain short while it went there).
With the put option contract, you have to pay a bit of a premium and you have to be pretty precisely right about the timing — if the stock collapses in October instead of May, you’re out of luck if you bought put options but could still make a lot of money by selling the actual stock short — but you can’t lose any more than what you paid for the contract. You can also get a little more complex and, for example, buy the $10 put and sell the $5 put — reducing your outlay to about $2.50 and also making your maximum return about $2.50 for a 100% possible gain (you profit from that $5 spread as long as the share price gets to $5 or below, and if you’re wrong you’ve reduced your outlay slightly by selling the out of the money put).
So … it turns out that you didn’t need a stock ticker revealed to you today, since Amoss hid the name in plain sight in the middle of his “presentation” — but hopefully we’ve elucidated just a little bit to help you understand the bet that Amoss is touting.
I had actually never heard of ZAGG before today, so I can’t say that I have a strong base of knowledge with which to wow you — I can say that I certainly agree that most of these kinds of cases and screen protectors and the like are commodity products, and that it’s hard to see any sustainable competitive advantage for any company selling this kind of stuff, though ZAGG does have decent reported sales and some innovative-sounding products and some decent branding if you want to look at the positive side.
Whether that and the speculation about management’s experience with “pump and dump” penny stocks or possible “aggressive accounting” regarding their sales to Best Buy means that the share price is bound to collapse in the next couple months, well, I obviously can’t tell you whether those speculators are right or not in predicting a forest fire at ZAGG — though with a huge short position, there’s at least some smoke in the trees. Their conference call with fourth quarter results is expected after the market close on Monday, so the market will have a chance to react as it likes on Tuesday the 15th.
As always, of course, it’s your money — so what do you think? Is ZAGG a worthless company? Will the world realize it in the next few months? Or is there some value in the stock that he’s missing? Let us know what you think with a comment below.