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Why One Short Continues to Strum Guitar Center's Strings

Even as the stock is cut in half, this column's original Guitar Center skeptic hangs tough. Also, the HMT hotline.

When this column first


Guitar Center


on March 31, under the banner, "Guitar Center Rocks, but Can its Stock Continue to Roll?" it was trading at 22. Asked why anybody who had bet against his company would wish they hadn't, CFO Bruce Ross warned, "For eight quarters we've either met or beaten Wall Street estimates, and we will continue to do that. And in time the Street will take care of the shorts."

Try telling that to investors who have lost their shirts. The stock, down by more than half since then, swooned 27% to 10 15/16 on Friday alone after the operator of musical instrument superstores warned that its second quarter won't quite meet analyst estimates. Part of the problem is expected dilution from its acquisition of

Musician's Friend

, a catalog retailer.


was expected.

What wasn't expected, at least not by the company's fans, was a warning that a slowdown in business trends will cause earnings to be about four cents per share shy of analysts' expectations for the second quarter. Oops. So much for meeting or beating every quarter. (Can't help but love execs that go on the record with definitive goals or boast about the past as if it's indicative of the future. Gives guys like me something to write about when the bottom falls out!)

With the stock singing such a sad song, you'd think the short-sellers would be packing up their bags and moving on. In the case of Guitar Center, think again. The short who originally shared his research with this column hasn't closed out his position, and has no intentions to anytime soon (unless the stock continues to drop) because he believes his original premise -- that superstore music retailing is way too competitive to create a good biz -- has only started to be played out. By good biz he's talking about such things as strong cash flows, high margins and frequent inventory turns. "Until I see an improvement in what drives the economics of the business, it will continue to deteriorate," he contends.

What's more, with Guitar Center's fair amount of debt, plus cash needs to open more stores, "The next announcement will be that they have to slow their store-opening rates," the short-seller, who specializes in retail, predicts. "All retailers who end up in this place where you never want to end up have to scale back expansion; that's always the second act." They were telling people as recently as four weeks ago that business was great," he adds. "But when the company is whispering sales are fine while the stock chart is telling you differently, it means they'll try to resist pointing out there's a sales slowdown for as long as they can."

Guitar Center, however, believes the slowdown is temporary. Chief Operating Officer Marty Albertson dismisses the short-seller's concerns about growth potential. While the company concedes new stores in existing markets resulted in more cannibalization than they would have expected, it believes it can balance that in the future with openings in new markets.

Despite growing competition, he adds, the company is sticking with plans to open 12 new stores this year and 14 next year; it currently has 61 stores. He adds that financing for the new stores will come from a combination of internally generated cash flow and a $60 million credit line from

Wells Fargo

TheStreet Recommends

(WFC) - Get Wells Fargo & Company Report


The company expects the current slowdown in business to reverse in the third and fourth quarters, increasing earnings by two cents in the fourth quarter.

The short-seller wishes the company the best of luck, but says, "Margins are down, expenses are up, cash flow is anemic and at the same time they're not making a lot of money, all of which points to a retail concept that shouldn't be public."

If so, it wouldn't be the first one.

HMT hotline:

So, the stock of

HMT Technology


appears to have settled down at around 3 1/4. And if you believe field reports, it's not going anywhere anytime soon. Reports reader (and spy) Greg Tomlinson: "As you may know, HMT's big facility in Fremont

Calif. can be seen from I-880, and I drive by it twice a day to and from work. The parking lot used to be full during the day and even into the late nights. But now it seems that there are hardly any cars in the parking lot even during the middle of a business day...

"I guess freeway visibility can work for and against you."

Bingo on that score. Lemme know when and if a "for sale" sign goes up!

Herb Greenberg writes daily for In keeping with TSC's editorial policy, he doesn't own or short individual stocks, though he owns stock in He also doesn't invest in hedge funds or other private investment partnerships. He welcomes your feedback at Greenberg also writes a monthly column for Fortune.