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Analysis: Short sellers wait to bet big against Groupon
(Reuters) - On paper, Groupon Inc appears to be a juicy target for short sellers: it loses money, it has changed its accounting twice, and its unproven business model faces competition from Google and Amazon.
But the shorts may have to wait as betting against the daily deals website is just too expensive right now because of its tiny share float.
To make money shorting the $15 billion company, which went public earlier this month, investors would have to see the stock go close to zero for a year-long bet.
"It would be very premature and highly risky to consider shorting Groupon soon after the IPO," said Fred Moran, an analyst at Benchmark Co. "It's very difficult to borrow the stock on a newly issued security and it has a very low float."
Groupon sold a stake of about 6 percent in its initial public offering, one of the smallest in the past decade.
That means there is little stock available for short sellers, who have to borrow shares before they can sell them. If the stock drops, they can buy it back at a lower price, return them to the lender and pocket the difference as profit.
A scarce supply had some brokers charging an annual rate of 90 percent to 100 percent last week to borrow Groupon stock, according to two hedge fund managers, one independent trader and one prime broker. They spoke on condition of anonymity to preserve their counterparty relationships.
It is unusual for a stock to cost this much to borrow. Shares of the heavily shorted Eastman Kodak, for example, cost 73 percent to borrow on average over the past seven days, according to Quadriserv AQS, which runs a securities lending platform.
A 100 percent rate, or negative rebate as it is known, means a trader has to pay $20 to borrow a $20 stock for a year. In this instance, Groupon stock would have to drop to close to zero within a year for a short seller to break even. So traders are only shorting the shares for very short periods, such as a few hours, or avoiding the trade all together.
"I'm not looking at it yet because of the borrow and float," said Jeff Matthews of hedge fund firm Ram Partners, which takes long and short positions. "Also, they have some smart guys there. It could become a legit business, although I doubt it. So waiting and watching."
Groupon's small float increases the chance of a short squeeze, which happens when a stock climbs and short sellers are forced to buy back shares to limit losses or close positions. Such buying often feeds on itself, pushing the price even higher and forcing other shorts to buy and cover.
Andrew Left of Citron Research compared the risk of shorting Groupon to betting against LinkedIn Corp, the professional networking website that went public in May, also with a float of less than 10 percent.
LinkedIn more than doubled on its first day of trade, then gave up a lot of those gains over the next month, only to jump about 75 percent by the middle of July. Such swings can leave short sellers nursing heavy losses.
Groupon may be an attractive short at some point, but "right now it could go higher too easily," Left said.
He added, "The stock market is a game of supply and demand, not fair when there is no float."
Citron Research publishes research on what it calls frauds and "terminal" business models. Left and others at Citron sometimes hold short positions in stocks profiled by the firm, and they do not disclose when trades are initiated or closed.
Another way to bet against the company is to buy put options, which give the holder the right to sell shares by a given date at a particular price.
The cost of put options on Groupon were high on Monday, the first day of options trading. Put options that expire in December and carry a $24 strike price were priced at about $3. Factoring in that premium, an investor would be betting on shares to fall below $21.
Call options -- a bet on a stock rise -- traded at a $1.50 premium, suggesting more demand for the stock to fall.
"Everyone is expecting the stock to slide and there is definitely a higher skew to put activity, but you need to really believe that there will be a drastic move on the downside to buy puts at this premium," said Ryan Detrick, senior analyst at Schaeffer's Investment Research.
Groupon shares closed down 0.74 percent at $24.07 on the Nasdaq on Monday, above their IPO price of $20 but below the $31.14 high reached on their first day of trade.
TAKE RATE AND VALUATIONS
Despite the risks of shorting Groupon, there is demand to do so. Last Thursday, a significant amount of Groupon stock was lent at a 90 percent negative rebate, according to Quadriserv AQS. Its lending service was closed on Friday and the positions were still open on Monday morning, spokeswoman Mary Haffenberg said.
Short sellers point to Groupon's take rate as a reason to bet against the company, as well as to the stock's rich valuation.
The take rate, or commission rate, measures how much money Groupon shares with merchants that take part in its daily deals. This rate has been falling in recent quarters as competition increases and the company branches out into new categories.
Groupon's take rate for spa and restaurant deals is about 45 percent to 50 percent, while Living Social, a top competitor backed by Amazon, has a take rate of 40 percent to 45 percent and smaller rivals are in the mid-to-high 30 percent range, according to Herman Leung, an analyst at Susquehanna Financial Group.
Leung expects Groupon's take rate to fall slightly over the next two years, but he warned that if new categories cannibalize sales, or competition forces lower rates, his forecast may prove conservative.
Leung forecast Groupon's 2013 earnings before interest, taxes, depreciation and amortization at $899 million. On that basis, Groupon is trading at a multiple of just over 17 times, which is a lot higher than Google, eBay, Expedia, OpenTable and Priceline.com, while cheaper than Amazon and LinkedIn.
(Reporting by Alistair Barr in San Francisco and Angela Moon in New York; Editing by Steve Orlofsky)
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