The shorts are looking to extract a pound of flesh from Texas brokerage
, but it's not coming easy.
Short interest in the brokerage and clearing firm rose by a whopping 432% between May 15 and June 15, the ninth-largest increase among all
New York Stock Exchange
traded stocks. But some stubborn resistance to the bear story will make handling this stock difficult for anyone with a weak stomach.
Until Southwest gets hitched or makes it clear that it has given up on its marriage hopes, the stock looks like it'll remain at the center of a classic Wall Street slugfest between the longs and the shorts.
Southwest bears say the firm's clearing business is struggling and that the market is assigning too much value to the brokerage, including a savings and loan it acquired earlier this year. (
wrote about Southwest's clearing business in May.)
Southwest Chief Executive Officer David Glatstein has been pleading his case and finds the growing short position extraordinary. He says the clearing unit's systems problems are in the past. The problems resulted in bookkeeping problems for Southwest and its customers, as well as an extended visit by regulators this spring.
"There are all kinds of negative rumors that have been somehow propagated out there in the marketplace that I think are generally unfounded," Glatstein says.
The Shorts Load Up
The shorts aren't buying it. In the latter half of May and first half of June, they were betting that the company's stock price had further to fall and pushed the short position up to 1.6 million shares, more than 20% of the estimated free
float of 6 million to 7 million shares. During that time, the stock lost 25% of its value.
Two sell-side analysts, however, are sticking by their Southwest recommendations in face of that mounting opposition. On June 15,
analyst Richard Bove raised his earnings estimate to 75 cents a share from 70 cents for the fourth quarter ending June 30, based in part on his belief that
Nasdaq Composite Index
market making and trading was stronger than he expected. Glatstein wouldn't comment on this number, and the firm won't report earnings for the fiscal fourth quarter until August. (Raymond James has done underwriting for the firm and has a strong buy rating on the stock.)
Another analyst, Jeff Putterman from Minneapolis-based
George K. Baum
, is resolute in his belief Southwest will be bought, probably in the next few weeks. In March Southwest announced it was looking for a buyer or a strategic investor. (Baum hasn't done any underwriting for the firm and rates the stock a strong buy.)
In the view of Putterman and Bove, the higher short position is merely a sign that the stock could be poised for a jump if there's a bout of short covering. As Bove explains, if something happens to push the stock up, the investors who have borrowed and then sold the stock will have to buy it back to cover their short position. That buying in turn would push the stock up more.
Putterman says the clearing problems are in the past and the other short arguments aren't persuasive enough. "I don't think that at $30 Southwest is a good short," he says.
It's not as though the stock spiraled during the short selling, but it did fall 25% to 31 5/8 on June 15 from 42 1/2 on May 15, while the
American Stock Exchange
broker/dealer index rose 5% during that same period. Since the beginning of the year, however, the stock is still up about 9%, putting total
market capitalization at more than $400 million.
The bull argument, however, is losing its hold over at least one sell-side analyst. On June 14, financial services analyst Lauren Smith, of boutique investment bank
Keefe Bruyette & Woods
, cut her rating on the stock to market perform from a buy. (Keefe has done underwriting for the bank.)
In her research note, Smith points out concerns about the state of the clearing business based in part on "inconsistencies" in what she had been hearing about clearing operations.
At issue is the introduction of a new software system and the ability of that new system to talk to the old one, which many of Southwest's more than 200 correspondent brokers are still using.
Smith's target for the stock is 32, about 18 to 20 below her estimate for a takeover value of 50 to 52 -- which is determined by breaking out the value of each unit separately. The difference between her target price and the company's takeover valuation is due to her questions about the state of the clearing business.
That takeover value is important because Southwest has been talking about a full or partial sale since at least March, when it hired a new investment bank
to advise it.
Glatstein says that the brokerage has begun meeting with potential bidders but wouldn't comment on specifics such as whether Dutch financial services giant
is among those he has seen. On Thursday, the
Wall Street Journal
reported from Europe that ING was interested in Southwest, citing unnamed analysts. Indeed, in May one person close to Southwest said that ING was among the companies Southwest had contacted. ING declined to comment.
Not everyone is convinced that the brokerage will be sold. One short seller who requested anonymity says that if a sale were going to happen, it would've happened already. Southwest's Glatstein says that the process is moving along but that the company isn't in a rush to do anything.
"We're going to take our time and talk to as many people as we can," Glatstein says. That, he says, could take "another several months to exhaust."
That should give the shorts and longs a few more rounds to fight it out.