It is no secret that newly listed companies face a host of issues that many established public companies do not face. Whether it be a lack of executional credibility or liquidity issues caused by the lock-up period, management teams are often fighting an uphill battle during the early days of being a newly public company. Regrettably, these issues can manifest themselves into short positions. Understanding the true impact of short positions gives management teams an accurate view to build a plan of action to combat a short thesis.
When a recently listed company is evaluating a short position, it is essential to evaluate the position as a percent of float rather than a percent of shares outstanding. As is common with newly listed companies, a large percent of shares outstanding will not be regularly traded in the open market. This is especially true in the early days following a company’s IPO before the lock-up expires. When you put your position in the context of daily volume, as a percent of float/outstanding share, you get a more accurate view of the active short position.
Interpreting the Short Position
- <5%: Should be of no concern
- 5%-10%: A developing view the stock will underperform
- Possible Drivers: Competitive products will limit upside and/or sentiment, expectations set by management are too high, whispers exist that create noise or challenges for new buyers
- >10%: A reasonably well-defined short thesis exists
- Drivers: Market participants have a view the stock will significantly underperform peers due to a lack of buyers
How to Resolve the Situation
The threshold for management teams to start actively managing communications around their short position is typically ~8%. At this level, it is essential to recognize there could be a building position on the horizon; management teams should actively work to mitigate that risk. The best and often easiest way to combat a building short position is to execute on your publicly stated goals, which should drive stronger financial performance. It can also be helpful to discuss short views and negative feedback with sell-side analysts to understand what they and the buy-side sees as “headwinds” to investment. A typical thesis might suggest one of the following explanations: guidance is too high, a lack of confidence in new product expectations, developing competitive landscape dynamics, cash burn issues, dilution concerns, etc. There are times when negative sentiment surrounding a company will lead to elevated short interest but not at a material level; it is only a cause for concern when short interest starts to become a considerable amount of shares outstanding or float. Understanding the perception of your company by outsiders is crucial to addressing the underlying problem.
The flip side of a low float for short investors is that it is very difficult to exit the position if needed. The shorts could be taking liquidity risk with their position, just as large holders do. If short interest is more than five days to cover (i.e., short interest ratio is days to cover), it will take the shorts some time to close out their position at 10-20% of daily volume. When liquidity is low and short interest is high, the short fundamental view will be compounded by the low liquidity of the short position. Shorts need to be right, especially when liquidity is low, so that the selling volume is available for them to cover their positions. If the shorts are wrong, there is not only no selling volume to cover other buyers in the market, but also the potential for a “short squeeze.” This will drive stock higher, mostly due to the lack of liquidity from sellers.
A low float is an unfortunate reality most recent IPOs experience, which usually introduces many company-specific issues. Understanding a company’s float in comparison to active short positions is crucial when thinking about external messaging, liquidity considerations, and business execution. Gilmartin Group can help you navigate floats and determine the smartest moves for your company. Contact us today.
Webb Campbell, Associate