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Why Short-Sellers Continue to Hang Around Scient Despite Its Spectacular Rise

Also, Conseco gets a conscience, and more chatter on a possible merger between Hollywood and Blockbuster.

Big thanks to JJC:

His

Scient

(SCNT)

piece Wednesday couldn't have been timed better. Turns out that when it hit the

TSC

big screen

yesterday, I was working on a Scient piece of my own that drew the exact opposite conclusion. (Imagine that!) Instead of talking about how its fundamentals are so good, I planned to focus on why they were so vulnerable.

Instead of talking about why anybody would've been a fool for selling Scient before its big run-up, I planned to mention why Scient investors shouldn't mistake momentum for margins. And instead of talking about how investors should ignore their intuition and hang onto the Scients of the world, I planned to mention why trusting your intuition plays an important role in sane investing. (OK, I really hadn't planned on writing that, but I

do

believe intuition plays a big role in when and what I decide to write.)

Herb's Latest: Join the discussion on

TSC

Message Boards.

And while you may be kicking yourself for selling Scient too soon, you can only imagine how short-sellers feel for thinking Scient was a layup just as many points ago.

Why, you can't help but wonder, would

anyone

stay short a stock like this?

I'll tell you why, or at least what one large short-seller who has suffered through the last 50 points told me: Because of the fundamentals inherent in the information-technology consulting biz. Scient specializes in the even narrower (and right now hotter) e-biz consulting niche. "The dynamics of the business are not commensurate with the valuation," says the short-seller.

Hot would be an understatement for Scient's growth, with revenue over the past three quarters zooming to $30.8 million from $9.4 million (or sequential growth of 49%, 75% and 88%). But that growth also means explosive growth of Scient's billable head count -- or actual consultants -- and that's the heart of this story. There are other issues, such as the company getting 17% of its biz in its 1999 fiscal year from dot-coms which were backed by the same VCs that now own 30% of Scient. ("You cannot grow your business ad-infinitum mooching clients from your venture backers," our short-selling source says.) And in a few days, company insiders will be free to sell shares as the post-IPO lockup expires. (More pressure on the stock, but so what? With its hyperinflated shares down 8% Wednesday, the company announced plans to split its stock!)

But the real issue is people -- and the cost of them. Unlike other Internet-related businesses like

Yahoo!

(YHOO)

, growth-oriented consulting firms must add new employees, capable of billing out their time, to generate additional revenue. Rule of thumb is a new employee for every couple of hundred thousand dollars of revenue. And in a fast-growing industry where there's plenty of competition for the same pool of employees, those employees don't come cheap. "Head-count costs are spiraling out of control," our short-selling source says. He figures that, year over year, "Scient's costs per billable employee have risen by about 35%. And that doesn't include noncash options charges."

For a peek at what Scient could look like, consider the case of

Cambridge Technology Partners

(CATP)

, a highflier in its not-too-long-ago heyday. After reporting a strong third quarter, the company said its fourth-quarter earnings would be well below estimates. Two of the reasons: higher turnover (as employees are lured to the likes of Scient) and high compensation costs to stop the outflow. Even rival

Viant

(VIAN)

, which is profitable, recently told analysts it's concerned about turnover as employees are attracted to the lure of higher salaries being offered by competitors and Web start-ups.

Where does that leave Scient? Let's just say existing growth rates aren't likely to continue. Scient itself says as much in its

SEC

filings, saying that it doesn't believe "this growth rate is sustainable for the long term." When it does slow, one thing is certain: Don't expect the momentum and daytrading crowds to hang around.

Scient officials, preparing for an analyst presentation today, were unable to be reached Wednesday.

Don't like what I wrote about Scient? Don't email me, post it on

TheStreet.com's

Herb on TheStreet

board so our discussion can be public.

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Conseco gets a conscience?:

If you haven't read

Shawn Tully's

excellent piece on

Conseco

(CNC) - Get Centene Corporation Report

in

Fortune

and how it was outdealt by the former used-car-dealing chief of

Green Tree Financial

, do so now. Speaking of which: Conseco prides itself on the amount of stock execs have bought. But the purchases have been somewhat suspect, because the company not only loans the execs money, but guarantees that if the company is sold for

less

than what insiders have spent to buy and finance the stock, the execs will be off the hook for the interest.

Seemed kinda smarmy. So much for execs having the same commitment as insiders. So, on Monday, I asked Conseco about the deal, which was detailed as recently as Oct. 18 in an SEC filing by CEO Stephen Hilbert. "Why," I asked, "should investors think such a purchase plan is advantageous? The execs appear to be taking no economic risk unless they leave the company. That would appear to put their conviction at

less

than the stock-purchase plan would suggest."

A spokesman responded that "directors and management can't conceive that the company would ever be sold at less than the purchase price of any program. To make that point clear to investors, directors and executive officers have agreed to eliminate that provision with respect to the shares they purchased in all programs."

So, they've scrapped the "off-the-hook-for-interest" part of the plan. Good for them. So far, there hasn't been any SEC filing or announcement regarding the change. But then again, hopefully that's one reason you're reading this column. (Don't forget to tell your friends and neighbors. Shameless hucksterism, I know; learned from the master.)

That's entertainment, update:

Nobody gave much of a hoot about an item

here six weeks ago suggesting that

Blockbuster

(BBI) - Get Brickell Biotech, Inc. Report

and

Hollywood Entertainment

(HLYW)

were considering a merger, or, in the very least, Blockbuster was considering buying Hollywood's

Reel.com

unit. Then, two days ago, Hollywood said it plans to file soon to spin its Reel.com unit off to the public. And, on Wednesday, Blockbuster announced a $30 million investment from

America Online

(AOL)

.

Still, my sources say, Hollywood and Blockbuster are flying the notion of some kind of transaction up the

FTC's

flagpole. Evidence of that comes from the latest issue of trade pub

Video Store Magazine

, which reports the FTC is interviewing independent video-store owners. Among the questions: What would happen if Blockbuster and Hollywood merged?

So, if they're planning to merge, why would Hollywood announce an IPO for Reel? According to my sources, to hedge its bets. You know that FTC -- not the most predictable bunch.

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

herb@thestreet.com. Greenberg also writes a monthly column for Fortune.

Mark Martinez assisted with the reporting of this column.