Short Sellers Get Schooled by this For-Profit Stock

By Linda McDonough

When does a 3% decline in revenue and a 13% decline in profits inspire a 30% increase in a company’s stock price?  Welcome to the perverse world of low expectations.  Strayer Education (Nasdaq: STRA) whiplashed short sellers and skeptics by issuing better than expected earnings and a positive outlook for summer enrollment.

On July 29th, Strayer, which once hit a high of $240 in 2010, jumped more than $11.50 in a single day to $53.34 thanks to a slight positive trend in its second quarter earnings.  The provider of for-profit post secondary education hosts students on 80 physical campuses and via online classes.

Revenue has declined more than 10% each year since 2011 and earnings have shriveled to a fraction of the level enjoyed in Strayer’s heyday in 2010. Overzealous recruitment at the industry’s peak ushered in a pool of under qualified students who sent student loan default rates through the roof.

Increased scrutiny from regulators regarding academic standards and recruitment policies have decimated enrollment numbers for almost every player in the industry.  Despite its stock being down 40% year to date, Strayer has actually been one of the better performers in the group.  Corinthian College, a fellow for-profit educator, closed its doors in April and filed for bankruptcy shortly thereafter.  

After the demise of Corinthian and a near-death experience for ITT Education (NYSE: ESI) in May, short interest piled up in almost every stock in the sector.  We’d attribute a large part of the jump in Strayer’s stock to buyers covering their short positions.

While Strayer’s earnings of $1.11 were higher than estimates of $1.00, they were still down greatly from the previous year.  2015 estimates of $3.59 reflect a 17% drop in earnings.  With the stock trading at 15 times earnings, investors may want to wait until Strayer produces consistent growth before enrolling in this stock. 

Around the Roadrunner Portfolios

Omnivision (Nasdaq: OVTI) is down 8% since our 11-11-14 inclusion in the Roadrunner Momentum Portfolio.  Despite a $29.75 all-cash bid by Hua Capital Management, the stock trades at $24. Buyers will enjoy a 22% gain if the deal is approved by government authorities.  In the event the deal is struck down we’d be buyers as the stock could move even higher if it remains independent based on positive developments with automotive and security products.

Omnivision currently trades at a discount to the all cash $29.75 bid that Hua Capital put forth last year.  Despite the company’s shareholders approving the deal in July, investors are worried antitrust issues will complicate its closure.

The United States has grown increasingly concerned about foreign purchases of domestic technology companies, especially in light of recent cybersecurity fears. Tim Keeler, a partner at law firm Mayer Brown, notes, “I think any Chinese investment in the U.S. is going to be looked at carefully”. Pundits are split on whether the deal will be approved.  While some point to the increased scrutiny of foreign deals, others note that Omnivision already generates 80% of its revenue in China and has several Asian based competitors supplying similar products.

Omnivision has made good progress in diversifying away from the increasingly commodity business of selling to cell phone manufacturers and towards security and automobile applications.  Chip based cameras are becoming increasingly critical components in the path towards driverless cars.  These chip based cameras are used for rear view backup cameras, lane change assistance and will eventually be used for road sign recognition capabilities. CEO Shaw Hong has deemed automobile and security applications the company’s new growth engines.  Chip based cameras are being integrated into security functions for remote monitoring and surveying.

Omnivision, whose fiscal year ended in April, should begin to see some earnings growth by the January 2016 quarter.  Until then the stock has $11.00 per share in net cash (cash less any debt owed) and trades at 16 times 2016 estimates of $1.54.  Analysts look for earnings growth of 48% the following year.  We see owning Omnivision as a win-win situation.  If the stock gets acquired at $29.75, investors will see a 22% gain.  If the stock remains independent, the return might be much higher.

Shares of Vipshop Holdings (Nasdaq: VIPS), the Chinese online discount retailer, can now be found on the markdown rack.  The company, famous for its 3-5 day flash sales on branded apparel, announced terrific second-quarter growth in revenue and earnings on August 10th.  However, revenue growth of 77.6% and a more than doubling of earnings was not enough to excite investors. The stock, down 30% over the last 3 months, has been battered by the crumbling Chinese stock market and the repercussions of a toxic mix of an expensive valuation and lowered guidance.

Although 100% growth is pretty hard to come by, Vipshop’s valuation assumed the company would continue to exceed investor expectations.  The stock was trading for 55 times 2015 estimates before earnings were announced.  After dropping to current levels, that forward P/E has shrunk to 35.

Investors were concerned that management’s guidance for revenue growth of 71-74% for the third quarter was lower than expected growth of 85%. In addition, two short seller reports surfaced, accusing the company of falsifying sales and cost data.  Although the company responded with a rebuttal, seeds of doubt were planted regarding the company’s business practices.

The misbehavior of the Chinese market has not helped. The Shanghai composite, which hit a peak in mid-June, is now down almost 30% since that apex.  In response to the market’s rapid drop, officials halted trading in almost half of listed Chinese stocks, banned selling by large shareholders and temporarily blocked all IPOs. This drought of liquidity has only helped to panic investors.

Incredibly, Vipshop is still up 24% since our May 2014 inclusion in the Roadrunner Momentum Portfolio. Despite the recent volatility, the company is still expected to grow earnings 70% in 2015 and another 55% in 2016.  With the stock now trading at 23 times the 2016 estimate of 87c, the stock reflects some of the risks going forward.

Platform Specialty Products (NYSE: PAH) has been on a buying binge recently.  The company, whose strategy is to acquire complementary specialty chemical companies and then trim expenses to produce higher profits, has acquired 5 companies since last November.

The most recent purchase of UK based specialty chemical maker Alent plc for $2.3 billion, was not the company’s largest but may add to its debt load significantly. The company has not announced how it will finance the Alent purchase.  The company has spent roughly $7 billion on various acquisitions since its original purchase of MacDermid in October 2013, including the purchase of Alent.

To date acquisitions have been financed via a combination of cash on hand, newly issued debt and most recently, an offering of 18 million shares sold for $26.50 per share on June 23rd, raising a total of $480 million.  As of March 31st, the company had $3.4 billion in debt and less than half a million dollars in cash. The lack of clarity on funding for Alent may be pressuring shares which are down 10% since the purchase was announced.

Platform Specialty is down almost 7% since our November 2014 inclusion in the Roadrunner Momentum Portfolio.  However, recent reviews from the company have been very positive.  Cutting redundant expenses for acquired companies and gaining economies of scale in purchasing raw materials have helped Platform achieve increased profitability ahead of schedule.

The company continues to focus on acquiring niche, specialty chemicals engineered for uses in electronics, automobile and agricultural applications.  Consolidating these unique products on one administrative backbone makes enormous sense and should propel Platform Specialty’s profits higher.

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