Credit where credit's due:
to Michael Kagan, of the
Salomon Brothers Fund
, who was on our
show several weeks ago. It was on that show he was asked about
, a pick from an earlier appearance. And it was on that show that he said he no longer owned it because he was troubled by the company's receivables. It was also on that show that
Gary B. Smith
said that based on his chart, he'd short it, and Cramer said, "It stinks."
Fast forward to this week: The Michigan company, which provides software and services for corporate networks, tumbled 40%, after the company warned that its fiscal fourth-quarter earnings would miss analysts' estimates. The news startled many on Wall Street (sorry to say you didn't get a heads-up from this column) but not money manager Aaron Edelheit of
Sabre Value Management
in Florida, who actually researched --
and sold short
-- the company
seeing Kagan on
show. He sent me an email the day
the bad news explaining why he thought the company was headed for trouble. (Better late than never!)
It's instructional because it shows that
other than Kagan, Edelheit and a few others were looking at the financials (if they were, they wouldn't have been startled by the announcement) and it shows what they would've found if they had bothered to look beyond what had been a good story.
"It looked like a great company," Edelheit says. "It was free cash-flow positive.
He defines free cash flow as cash flow from operations minus capital expenditures and capitalized software. It had no debt. And it had great margins. Then it started acquiring companies and it took on around $500 million in debt. And its free cash has turned negative."
He backed into all of that after looking at the company's accounts receivable, thanks to the tip, via our Fox show, from Kagan. As readers of this column know all too well, a sudden rise in accounts receivables (the amount owed by customers) is always noteworthy, especially if they rise faster than sales and/or become a greater percentage of sales.
That suggests a company is pulling out all stops to convince customers to take more product than they really need. It's especially worth noting when the days outstanding of receivables -- the amount of time customers are taking to pay - also are rising. The higher the number, the worse it is. (Normal for a software company is 45 days.)
At Compuware, long-term receivables jumped from $145.8 million, or 27.85% of sales in March 1999, to $380 million, or 60% of sales, in December. What's more, days outstanding of all receivables in December leaped to 153 days from 114 days in March. A closer scan of the last 10-Q offers an explanation: Most of the company's contracts include deferred payment terms -- mostly for software maintenance, which clients are required to take as part of the deal.
According to the disclosure (and this is the important part, folks), during the past year the volume of contracts with deferred revenues posted "significant growth as the practice expanded internationally and as the company added additional sales representatives focused exclusively on these types of transactions."
These type of transactions?
Suggests to our emailing money manager that the company was trying to mask a slowdown in revenue by making acquisitions and entering into the kind of contracts that generate higher receivables. "So, they stole from future quarters," he says, "and eventually they
to pre-announce bad news."
Which they did, and which could be the first of several bad quarters for Compuware.
A Compuware spokesman didn't return my call seeking comment. The company, however, has told Wall Street that it will have more info on receivables and cash flow when it reports earnings May 1 -- and that it expects receivables' days outstanding to fall. What they say, Edelheit says, will determine whether he covers his short.
What happens when shorts get squeezed out of their stocks via the mother of short squeezes? You get what is happening now -- the mother of long squeezes!
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
email@example.com. Greenberg also writes a monthly column for Fortune.
Mark Martinez assisted with the reporting of this column.