At the height of the COVID-19 pandemic in late 2020, Meme stocks captured the imagination of traders and speculators who were anxious to enliven their days amid the lockdown. The first in a long line of short-squeeze plays kicked off with a single stock: GameStop (GME). Concerns about rising competition and declining foot traffic attracted so many bets against its future that short interest soared to more than 100% of the shares outstanding.
Scion Asset Management’s Michael Burry took a contrarian view on GME, arguing that it could return to profitability in a couple of years instead of going bankrupt. His thesis captured the imagination of Reddit investor groups and YouTube content creators in mid-2020.
The initial buzz quickly snowballed into buying momentum in the stock by late 2020. The price increase drove out some short sellers and attracted various big-name investors such as Elon Musk and venture capitalist Chamath Palihapitiya.
GameStop’s stock price surged due to a short squeeze on major hedge funds that were short the stock and forced to sell to cut losses. Incredibly, the stock price went from less than $5 a share to $325 in just a month.
The extraordinary gyrations of GameStop, AMC Entertainment (AMC) and more than a dozen other companies have been well-documented. However, short squeezes in general are rarer than most investors would think. In fact, many years have nearly zero, while other years post more than 100, according data published by the CFA Institute.
Interestingly, the five most active short squeeze months, normalized by the total number of contemporary equity listings, were February 2021, May 2020, October 2008, February 2000, and October 1974—all periods of extreme market uncertainty and financial crises.
The squeeze play of this year is Carvana (CVNA), which is the most heavily shorted stock in the Roundhill Meme ETF (MEME) and has a short interest of nearly 40% of the shares outstanding and nearly 60% of the float. After hitting $360 a share in August 2021, CVNA shares plummeted to a low of $3.55 earlier this year amid speculation of bankruptcy. The company, once a pandemic darling, laid off workers last year in an effort to cut costs and preserve cash.
Amazingly, the stock traded above $57 on July 20. Carvana short sellers have lost more than $2 billion this year as the online car retailer's stock has rallied as much as 1,000% year to date, according to S3 Partners.
Long Odds for Short Squeezes
Short squeezes are more likely to occur in stocks with relatively few traded shares and commensurately small market capitalization and float. Short squeezes may also be more likely to occur when a large percentage of a stock's float is short, and when large portions of the stock are held by people not tempted to sell.
In order to assess the likelihood of a stock becoming a potential target for a short squeeze, four essential criteria warrant consideration:
High short interest
Thinly traded shares
Elevated market uncertainty
Speculative technologies with yet-to-be-determined long-term value
In other words, if you’re investigating short squeeze prospects, a good place to start is among the 1,200+ companies tracked by Third Stream Research in TMT, Biotechnology, Healthcare/Life Science, Medical Devices, and Cleantech.
A CFA Institute study into the dynamics of short squeezes has yielded insightful findings, drawing upon data encompassing all publicly listed US companies spanning from 1972 to 2022.
The study distinguishes between two categories of short squeezes: ‘strict’ and ‘loose,’ each characterized by specific patterns and durations. A ‘strict’ short squeeze involves a stock's rapid ascent of 50% to 500%, followed by a subsequent decline to a range between 80% and 120% of its former value, all unfolding within a single month. In contrast, a ‘loose’ squeeze unfolds over two months while adhering to the same price fluctuations.
Among the various sectors, the frequency of strict short squeezes varied significantly. Notably, the biotech sector emerged as the most susceptible to these market maneuvers, recording 20 occurrences in 2000 and 23 in 2020. These particular years represent the zenith of short squeezes for any sector, showcasing the pronounced influence on biotech stocks. Close behind in vulnerability was the software and computing sector.
Short Squeezes by Sector
Source: CFA Institute
The reason behind the heightened incidence of short squeezes in biotech and software/computing is rooted in their heavy reliance on novel and often unproven technologies. This characteristic renders them more prone to speculative activities, complicates the process of valuation, and, as demonstrated by the collected data, designates them as likelier targets for short squeezes.
However, the CFA Institute researchers warn that short squeezes are not commonplace events, even if all four aforementioned conditions converge. Consequently, predicting their occurrence remains a daunting task, with long odds of success. Notably, the extraordinary case of GameStop exemplifies that market outliers can disrupt conventional expectations.
3 Short Squeeze Candidates
(>$200M market cap with high short % of float)
Buying a stock in anticipation of a short squeeze adds complicated tactical and speculative dimensions to what is already a challenging task. Attempts to accurately forecast a short squeeze is a low probability exercise and it is doubly risky because if a squeeze does occur, a stock will usually retract gains very quickly.
We identify three companies in our universe of coverage with among the highest levels of short interest relative to their stock float. However, this single technical indicator is only a small piece of the puzzle; analyze these companies as you would any small-growth prospect.
Allogene Therapeutics (ALLO)
Price (7/28/23): $4.92
Market Capitalization: $717M
Shares Outstanding: 145.8M
Short Percent of Float: 53.9%
Short Interest Ratio (Days To Cover): 19.8
% Owned by Insider: 29.4%
% Owned by Institutions: 98.6%
Total Cash: $471M
ALLO’s CEO Dr. David Chang opened the company’s Q1 2023 Earnings Conference Call on May 3 with the following statement:
“We often get questions about our stock price weakness. Yes, the market is challenging. Yes, cell therapy stocks are temporarily out of favor. And yes, many of us in the industry find it frustrating that progress is not always rewarded in real time. But during times like this, it helps to remember that best marker of success is not necessarily a stock price, rather it is the impact companies in our sector are having on patients.”
Chang's confidence in Allogene’s clinical data sets and the positive impact of its investigational products on patients is evident, as highlighted by his encounters with two patients. Their stories serve as living proof of Allogene's success in delivering effective therapies, according to Chang.
However, the growing demand for autologous CAR (Chimeric antigen receptor) T-cell therapies raises concerns about meeting patient needs. By 2030, it is estimated that around 300,000 patients with lymphoma or myeloma will be eligible for this treatment, yet only ~10% will likely receive it. This would require an overwhelming 30,000 individual manufacturing runs.
Last year's reported sales necessitated around 6,000 to 7,000 runs, straining the system. Recognizing the urgency felt by patients waiting for treatment, Allogene is dedicated to bringing its AlloCAR T products to market promptly.
In contrast to autologous cell therapies, Allogene's trials allow patients to start treatment shortly after enrollment, without the need for bridging therapy, which often comes with marginal benefit and toxicities. The one-time infusion of cells offers convenience and potential long-term remissions.
To help achieve their goals, Allogene hired Tim Moore as the new Chief Technical Officer. Moore's experience in delivering CAR T products and navigating complex chemistry, manufacturing and control processes will be vital in scaling and optimizing manufacturing for allogeneic approaches.
BioXcel Therapeutics (BTAI)
Price (7/28/23): $9.58
Market Capitalization: $279M
Shares Outstanding: 29.1M
Short Percent of Float: 43.1%
Short Interest Ratio (Days To Cover): 3.5
% Owned by Insider: 31.2%
% Owned by Institutions: 53.5%
Total Cash: $165.5M
On May 8, BioXcel hosted its quarterly earnings conference call. Its CEO was upbeat about three key readout across the company’s lead neuropsychiatric program, BXCL501:
“These data readouts are on track and expected to enable significant potential market expansion. The overall agitation market remains underdiagnosed and underserved. There are an estimated 139 million agitation episodes occurring each year in the U.S. across our three priority indications, bipolar disorder, schizophrenia and Alzheimer's disease. Similar large market exists for these conditions in other geographies outside the U.S.”
BTAI shares closed at $27.26 the following day, but proceeded to steadily decline over the next several weeks. On June 29, the stock crashed 64% to $6.39 in response to the release of Phase 3 trial results for Alzheimer’s candidate BXCL501. Despite reaching its main goal in the trial, investors reacted to its data integrity issues. The conduct of a principal investigator at a study site led to concerns regarding the timeliness of reporting a serious adverse event in the placebo arm.
Short interest in BTAI surged from 3.34 million to 8.67 million over the two months from May 15 and July 14. This stock is extremely volatile and is prone to swing 50%+ up or down in reaction to upcoming clinical trial results. High ownership by insiders and institutions is apparently not enough to keep the shares on a steady keel.
Stem Inc. (STEM)
Price (7/28/23): $6.62
Market Capitalization: $1.0B
Shares Outstanding: 155.5M
Short Percent of Float: 26.9%
Short Interest Ratio (Days To Cover): 7.1
% Owned by Insider: 5.3%
% Owned by Institutions: 72.8%
Total Cash: $205.5M
In a major blow to Stem, Inc., the intelligent energy storage network provider, its shares hit an all-time low in May, triggered by downgrades from prominent analysts at Bank of America (BAC) and Wolfe Research. The analysts' reports raised concerns about the company's latest convertible issuance and its potential impact on investor confidence, particularly due to working capital considerations.
Stem, Inc. operates in the U.S. and internationally, offering energy storage systems sourced from OEMs. Additionally, the company provides Athena, an AI platform that enables battery hardware and software-enabled services for operating energy storage systems.
The assessment by BAC's analyst highlights a critical issue in Stem's business model. While the company positions itself as a software-focused player in the energy storage industry, slow revenue realization from this segment means that it heavily relies on lower-margin hardware and service businesses to drive EBITDA growth.
Despite management's assurances of a rapid scale-up in services to offset declining hardware sales, BAC's report expresses concerns about the uncertainty arising from the latest capital raise and pivot toward establishing a novel services business. This has further accentuated the apprehensions regarding Stem's future prospects.
Wolfe Research's analyst, while acknowledging strong bookings growth for Stem, points out that the elongated backlog conversion poses a significant headwind for the higher-margin software segment. The company would likely need to recalibrate its long-term expectations, and until there is tangible evidence of improved execution, investor sentiment is expected to remain depressed.
Wolfe Research also expressed surprise at Stem's recent 4.25% convertible offering, as it had not anticipated such funding needs for the year 2023. This development has raised questions about the company's anticipated cash generation outlook, adding to the mounting concerns surrounding Stem's financial position.
Overall, the combination of BAC and Wolfe Research's downgrades has weighed on the stock. As the company navigates the challenges, it will be under intense scrutiny from investors and industry observers to demonstrate a clear path to sustainable growth and profitability.
Even when the key factors qualify short squeeze candidates, the situations will always be uncertain and fraught with complexities. It is risky to overemphasize any strategy focusing on squeeze plays because of the additional technical issues. Exercise caution and avoid relying on predictions of such events unless you have done the fundamental research.
See you next week.
Josh
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Disclaimer
The content provided in this newsletter is intended to be used for informational purposes only. It is important to do your own analysis before making any investment based on your own personal circumstances. You should take independent financial advice from a professional in connection with, or independently research and verify, any information that you find on our website and wish to rely upon, whether for the purpose of making an investment decision or otherwise. Joshua Levine and Third Stream Research were not compensated by any company, directly or indirectly, mentioned in Confluence, and we do not own shares in any companies mentioned.