by Travis Johnson, Stock Gumshoe | October 26, 2010 1:16 pm
I always like to write about a bear case on a stock, or a put-buying or short-selling teaser, because they’re so rare — most people wouldn’t consider shorting stocks because of the different risk profile and the unfamiliar process, and many folks even think there’s something vaguely un-American about betting against a stock.
And, of course, betting against selected stocks can make you a fortune, just like betting on other stocks — the secret, as always, is choosing the right stock. And maybe being a little lucky in the bargain, and eventually getting the rest of the world to recognize that you’re right. I’ve written about only a few short bets over the years, including Porter Stansberry’s argument that the hard disk drive makers are going kaput (the stocks are down considerably since I wrote that idea up, and it’s a similar “technological obsolescence” argument to today’s pick) and Dan Amoss’ unprofitable bet against Bank of Montreal last year, but few brave the short waters in teaser-land very often, probably in part because it tends to attract controversy in a way that “long” bets do not.
This latest teaser from Louis Basenese aims to get you to sign up for a membership in the Oxford Club, which also means this stands out as a bit unusual. The Oxford Club’s Communique is really a jack-of-all-trades entry-level newsletter with a very large circulation — not the kind of letter that typically does a lot of short selling or options trading, since those are generally considered “more sophisticated.”
The vast Stock Gumshoe audience, however, is chock-a-block with sophistication … so let’s figure out what he’s talking about in predicting doom for this unnamed large cap stock, shall we? At the very least, we can name that secret stock and let you know how folks might bet against it if they were so inclined.
To begin, then … here’s what the tease tells us:
“On Monday November 1, a tiny group of investors stand to get very rich… while most will lose a fortune.
“On that day, the walls will come crashing down on one large-cap tech company. And almost no one sees it coming.
“… Not top-tier analysts from the likes of Barron’s or Wall Street’s most respected firms who say ‘…the company is growing.’ That it’s ‘The best in breed.’ And ‘Well positioned to outlast competitors.'”
And then he clarifies that when you make money off this bet, you won’t be shorting the stock (which leads me to think that he mus be recommending that investors buy put options — more on that in a minute):
“… by making one simple move, you could MAKE $9,000 or more off this crisis opportunity. You won’t even have to short the stock. And as things get worse for this company in the coming months, you could collect even more money…”
And he starts to toss out some clues about what he calls this “ticking time bomb:”
“Based on a recent study by research firm iSuppli, many analysts predict that very soon, there will be NO market for this firm’s main product.
“And once the mainstream discovers this ‘dirty little secret’ on November 1, expect $947 million to come flooding out of this company.”
So what is happening on November 1? He says that the company will make an important announcement (he describes it as a “confession”)…
“The CEO is set to reveal specific information about the company’s product line that will finally tip off the rest of the world to what I already know…
“This company’s primary product – its lifeline – is about to become obsolete.
“In fact, by January 1, just a couple of months from right now, as many as 108.9 MILLION people in the U.S. alone are predicted to have this same technology in their hands… but for free.”
So if that’s true, why isn’t everybody already betting against this stock? Well, the tease then goes on to note that it remains a “Wall Street darling,” and that “Investors Business Daily called it a ‘winner'” on September 28.
He compares the market for this company’s products to some well-known crashing consumer products — AOL and their demise when the internet and email become more easily accessible for everyone; the PDA when smart phones took over.
And the teaser tells us that …
“There’s no viable back-up technology – like the Palm Treo – to rescue the company from complete obsolescence.”
We’re also told that the company tried to come up with a new product line that would “rescue” them …
“… this company released its long-awaited Smartphone two weeks before the newest iPhone came out.
“But despite the head start, it only sold 20,000 units compared to Apple’s 1.7 million in the same timeframe.
“It’s no wonder why…
“PC World said ‘it isn’t quite cutting-edge’ ‘…some operations felt sluggish,’ and ‘there are better choices for a general-purpose Smartphone.’
“Bottom line: This foray into the Smartphone arena was nothing but a multi-million dollar waste of money.
“By all accounts, it also means there is NO back-up technology to save this Ticking Time Bomb from disaster. The company must rely on a now unnecessary product to survive.
“But Wall Street still doesn’t see the writing on the wall. Just a couple of weeks ago, in fact Goldman Sachs upgraded its rating on the stock.”
Exciting, eh? You get to profit from the demise of a stock, but, even better, you get to bet against Goldman Sachs!
So who is this “ticking time machine” that Louis Basenese says will “crash and burn?”
Toss all that into the mighty, mighty Thinkolator, and we have to conclude that this is …
Not the kind of stock that lots of folks generally like to bet against — it has pretty high insider ownership (about 5%, almost all by one person), a fairly big dividend, plenty of cash and no debt, and it’s profitable. And yet, still, almost 14% of the free float on these shares is sold short. Why?
Well, it’s largely for the reasons that Basenese teased us with above — Garmin is the biggest pure play on Global Positioning System (GPS) devices, including handheld and car-mounted GPS as well as more sophisticated boat and aviation satellite navigation tools. That was great for a while, with a strong market position in a hot consumer product in particular (those little handheld screens that you can suction-cup to your windshield) … but as competition mounted and lots of other companies started selling similar devices, prices and margins suffered (remember seeing these a few years ago for $500? There are lots of models under $100 now) … and now, with so many people seeing that the future is a GPS-enabled smartphone in every hand, investors are wondering whether anyone beyond the geo-caching enthusiasts and hard core navigation fiends will buy a separate GPS device. Or consider them more than a fun little toy.
And unfortunately for Garmin, they don’t own the satellites that provide GPS service — those are essentially a public utility that anyone can use (unless the Defense Department takes them back). And they don’t own the mapping data, (they mostly license that from Nokia, which bought Navtech a few years ago), so they have one real revenue stream: selling hardware.
That can be a really, really profitable business, of course, and it has been for them for years — and the business is still pretty big, with sales around $3 billion a year, though that appears to have plateaued over the last couple years after several years of face-melting growth (2009’s revenue was below 2007, and the trailing 12 months are not substantially better than that).
But it’s also a business with few barriers to entry, so they have to count on a brand name to drive sales, and on continued R&D and product enhancements to keep their core customers excited by new toys — it seems like they’re still doing really well in the outdoor enthusiast/fitness category, with lots of new tools that are more specialized for geocaching, or running or bicycling, for example, but it’s also easy to see how this could be a losing battle as the value of their innovations fails to outpace their competitors enough to let them maintain some semblance of pricing power. There’s only one other relatively big “pure” GPS device company, TomTom (which uses the other big geographic data provider, TeleAtlas) — TomTom is also seeing roughly flat sales, they’re a bit smaller than Garmin (overall sales about 2/3 the size) and are much more car-focused, but they also have a much larger chunk of the European market.
And Garmin’s brief foray into the phone business through their Nuvifone and Garminfone, partnered with ASUS (also called ASUSTeK Computer) appears to have been a pretty complete flop from just a quick glance — they made an announcement today that the partnership is effectively ending, which could possibly be the announcement that Basenese was expecting (ASUS reports earnings on Thursday, and Garmin next Wednesday (11/3), so “November 1” is a reasonable timeframe to expect news).
The announcement, in case you don’t feel like reading it, was that after developing six phones they’re not going to design or sell any more but will keep supporting the ones they’ve sold … and that ASUS will build their own Android phone using Garmin tech for the navigation bit, and “Garmin will expand its mobile handset application development and plans to offer navigation and other applications through certain consumer application stores.” Last I checked T-Mobile was still selling the Garminfone, but it is “on sale.”
So as someone who didn’t look into this at all before a few minutes ago, it does sound like the general position is that “the phones didn’t sell, so we’re going to let ASUS try making one on their own with some Garmin nav software built in, and we’ll try to make something else … and we’ll at least try to sell some Apps for the iPhone.”
And yes, I’d have to agree that this sounds like a kind of sad and probably doomed strategy — though probably not nearly as doomed as the original plan to sell their own navigation-centric smartphones, so “giving up” might have been the best plan… and it was certainly well received by the market, the stock was bid up about 5% today, and I’d wager that a large part of that was because investors were afraid that Garmin would sink a lot of money and time into a “unlikely to be a big hit” Garmin-branded smartphone. Giving up on a line of business that most people think will fail (and fail expensively) is usually good news for a stock.
And I wouldn’t go so far as to say that means the stock will crater because they’ve failed to develop a new successful smartphone device (or another “killer device” beyond the handheld navigation gadgets they sell now) — the stock seems to reflect no particular optimism about the phone business and the key, I suppose, would be figuring out how much of a sales presence they’ll be able to continue to have as smart phones, GPS-enabled “less smart” phones, and built in auto navigation systems eat into that part of their business, and whether they can maintain some reasonable profit margins on what I think we should expect will be a slowly moving sales base (I don’t know if sales will go up or down, but I’d guess that they’ll move far less dramatically in the years ahead than then did when they nearly doubled each year from 2005-2007).
So this is where it gets tricky — how and when does the market decide that Garmin is going to stop having any competitive advantage over its many GPS device rivals, or is going to lose market share and/or pricing power? It’s been a gradual process, but they do have a real market niche and a brand name so they’re not going to disappear overnight … and there’s probably some chance, though I can’t calculate it, that they’ll develop more “must have” products in the years to come that get the mainstream excited again, maybe even some connection to a new satellite-based air traffic control system (they don’t appear to get a lot of credit for their aviation or boating products), or even that some kind of Garmin phone will be big eventually.
Remember, this is still a company that has close to $3 billion in sales (analysts think that goes down a bit next year, and grows at about 5% a year thereafter), and that has profit margins of better than 20% — they could suffer quite a bit and still be worth something, and they have enough cash flow and cash on the books to get value investors excited if the stock falls by much from here. There are plenty of folks who will take a look at a stock that trades for 7X cash flow, even if the business seems to be declining.
Basenese’s argument seems to be that the stock will fall about 15% (he uses the $947 million figure, which is close to 15% of their $6.5 billion market cap) … and that it will happen in the next few months. That certainly seems feasible (you can make the “probable” judgment yourself), though it also doesn’t really seem like a “crash and burn” type of collapse … So if you agreed with him, and, like him, didn’t want to short the stock directly, how would you speculate on that strategy?
Well, buying puts is the easiest way — a put option is, essentially, a bet that a stock will fall. The buyer of a put option buys the right to sell a stock at a particular price anytime before the option expiration date (and the seller of the option promises to buy that stock at that price), so here’s one possibility for putting Basenese’s conviction into action:
He thinks this starts on November 1, but will continue for a few months as the stock, presumably, continues to fall. So let’s say that an aggressive person might try to bet on this fall with a put option with a November expiration that bets on a move down in the stock within the next few weeks, and someone a bit more cautious might give it more time and choose the April expiration date (you pay more to get more time, giving you more of a chance to be right if opinion turns against your thesis — as it might have for Basenese today with the happy move on the phone announcement).
I’m absolutely not recommending any of these ideas, mind you, and there are all kinds of variations on options trading that you could try to bet on a fall in GRMN shares … but here’s how they could work:
November: you could buy the November puts with a strike price of $31 (meaning, you get the right to sell the stock at $31 before the option expires on November 19). That option is a lot cheaper today than it was yesterday, thanks to the big jump up in the shares, but last I saw the ask for these contracts was 68 cents per share (so $68 per contract, each contract gives you the right to sell 100 shares). That 68 cents per share means that the shares would have to fall to $30.31 for exercising the option to be profitable, but most people never exercise options (they just sell back the put option), so we can assume that if the stock falls by 10% to roughly $30 that this option will go up in price and you could sell it back at a profit. If the company loses $947 million in market cap, that would mean that the stock falls by roughly $5, so let’s say it falls to $28.50. That would mean that your option is now worth $2.50 per share, so you’ve profited roughly 300%. If the stock remains above $31 from now until November 19 and you don’t get a chance to sell at a profit, you lose all of your investment as the option expires worthless, and if it falls just a hair under $31 you might recoup some of your money. That means the stock has to move quite a bit in a relatively short period of time, but there is an earnings announcement in there so certainly anything is possible.
April: that’s for the November expiration, then, which gives you just about four weeks to be “right” — what if you wanted to give yourself some more time … you’re sure that Garmin will go down, but it might take a while for everyone else to come around to your way of thinking and sell their shares and drive the price down? Let’s see what would happen if we just wanted to bet that the shares would fall by 15% before April.
Well, that would cost you quite a bit more — the put option contract for the same strike price in April last changed hands right around $2.50, so if you want to give it that much time you also have to build in a further fall in the stock … if GRMN falls by 15% between now and April, you’d probably roughly break even with an unprofitable trade (at least in “exercise” terms — the options prices can fluctuate considerably with sentiment) you’d have to see the stock fall below $28.50 to make this profitable, since you paid someone $2.50 for the right to sell it at $31, and a 15% drop would put the stock price right around $29. And just as with the November option, if the stock never falls that far — or if it does and you don’t sell the option and then the stock goes back up — then you’re out of luck and can certainly lose your entire “bet.”
That is the nice thing about options, however — unlike with short selling trading volume can be very light and you have a strict deadline by which you have to be right (the expiration date), and you pay for the privilege of margin, but you can’t lose MORE than you wager if you buy a put or call option. That’s in contrast to selling short, which gives you that theoretical bogey of unlimited downside (a stock can only go as far down as zero, but there’s no limit on how high it can go if you’re wrong). Of course, in practice the fear of short selling is probably overdone, since a mainstream stock rarely goes up so dramatically high in a day that you couldn’t cover your short position, but the potential is always there for a catastrophic loss and investors hate even the theoretical chance that they’d have to send in new cash to their brokerage account to cover a short that busts their margin account. So buying a put option, though a bit more expensive than selling short, at least tells you exactly how much you can lose: all of it, but no more.
So what do you think? Do you foresee bad days ahead for Garmin? Love the little Nuvi navigation things and wonder why everyone else doesn’t feel the need for one, or do you let your iPhone tell you where to go? Feel like betting that the stock will fall (a better bet to make today than yesterday, at least)? Let us know with a comment below.
Full disclosure: I don’t own any of the stocks mentioned above and won’t trade in any of them for at least three days.
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