Ongoing losses at EarthLink (ELNK) make it an easy stock to hate. Shares have rebounded recently after a fall in February and are near heavy overhead resistance at $7.45.
In 2007 the stock has ranged from about $6.60 to $7.50, The shares
$7.60 intraday Feb. 7 after an upgrade from Goldman Sachs, but the stock then slipped from late February through mid-March.
The shares then got a boost from a venture with
and have trended higher since then. With the stock now near its six-month highs, it is vulnerable to disappointment when earnings come out later this month. As I discussed in my
, I use quantitative data from
to identify momentum trading ideas. I screen first for growth in sales and earnings, and then I check to see if the price chart confirms the trend.
EarthLink ranks very low for price and earnings momentum as losses continue to mount, margins continue to fall and finances continue to weaken. The company has had a hard time diversifying out of its roots in dial-up Internet access, and it's burning up lots of cash in the meantime. It lost 20 cents a share in the fourth quarter, though revenue grew 5%.
And 2007 doesn't look much better: The firm expects flat sales and a loss of over $1 per share. Wall Street
EarthLink to report a loss of 30 cents per share on sales of $328 million. This compares with last year's
of 12 cents per share on sales of $310 million. Over the last two months analysts have grown more bearish, and they now expect greater losses for the March quarter and for all of 2007.
A Boost From TiVo
The stock rebounded after March 6 when EarthLink
that it would team up with TiVo. The firms will offer a bundle of services that combines digital video recorders (DVRs) with Internet service. I don't see why this alliance between two second-tier firms is bullish. Most cable TV firms offer DVRs, so I guess the target audience would be DSL customers. It's a logical move but nothing that changes the game for EarthLink.
EarthLink has no debt to speak of, but poor liquidity led the firm to offer $237 million in convertible debt last year. Free cash flow in the last quarter was less than $1 million, so the company could see a solvency squeeze as investors get impatient.
This is one reason why this speculative stock is likely to get hammered in a general market correction. And as such, I believe the stock is poised for a correction, and I'd put in a short sale here with a stop loss at $7.50 with a target of $6.50. I expect disappointing earnings on April 24 to hurt the stock, providing a short-term catalyst and a convienient expiration date for this trade idea.
A takeover or radical restructuring could boost the shares, as would the success of Helio, a wireless joint venture in South Korea. But Helio is expected to lose about $350 million in 2007 after losses of $190 million in 2006, and EarthLink has a 50% share in these losses.)
EarthLink's market cap stands at about $900 million, and about 15% of the shares are
. I'd rather see a smaller short interest, but over 2 million shares trade daily, so the shares are quite liquid.
I would want to be short this stock when the company reports earnings on April 24. This short idea is broken if the stock closes above $7.50 or if the trade doesn't show a profit by the end of April.
Robert Martorana is the director of content, TSC Professional Products. In keeping with TSC's editorial policy, he doesn't own or short individual stocks, although he owns stock in TheStreet.com. He also doesn't invest in hedge funds or other private investment partnerships. Martorana focuses on creating and delivering trading idea products and services based on TheStreet.com Ratings. He has more than 20 years of Wall Street experience and was most recently a portfolio manager and head of U.S. equity research at Barclays. Prior to 1996, he managed small-cap stocks at Schroder Capital Management International, with a focus on energy, basic materials, and capital goods. He was also an equity analyst at Vontobel USA and was an editor and senior industry analyst for The Value Line Investment Survey.
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