A Good Short?

I urge you to read Chapter 12 of CI90s for a full explanation of what to

look for and where in short sales. But, in essence, a good short has no

earnings (preferably no revenues), little cash, an unproven product, and a

huge market cap engendered by promotion. I especially like to short stocks

run by con artists, since they inevitably self-destruct; and I like the

feeling of doing a public service while lining my pockets.

I only regret that researching shorts is almost a full-time job in itself;

it would be nice to find a new one every month. Especially now, at what

appears to be the peak of one of history's great stock market manias.

As I explain in CI90s, an ideal place to shop for shorts is on the small

Canadian exchanges, which are awash with undercapitalized start-up ventures.

Recently one stock has come to my attention that fits all but the last

parameter-Polyphalt (PLYF, C$11), traded OTC in Toronto. The company appears

to have a technology that, using polymer additives, makes asphalt paving

more durable. I've read the stuff in their care package, and it sounds

good-until you look at the financials.

But I've seen dozens of really great-sounding little industrial deals, and

they all seem like the next Microsoft. Almost all of them go bust, however,

for more reasons than you can count. They can't raise money. Or can't sell

their product. Or can't control expenses. Or there are a dozen other

competitors that they forgot to tell you about. Or a glitch develops in the

technology. Or a thousand other things. Startup R&D deals are, almost

without exception, the best way there is to melt down your portfolio. I

speak from experience.

Polyphalt started trading in 1994, but was recommended very

enthusiastically in a large newsletter at about C$1.30 this April, causing

it to run as high as C$18 based on absolutely nothing other than blind

enthusiasm.

It's certainly not based on the balance sheet, which shows (as of Jan. 31)

C$151,176 in cash and equivalents. Nor is it apparently based on what they

are paying-over time, not cash-for the technology to its original owner, the

University of Toronto Innovations Foundation-C$500,000. Last year's burn

rate-wages, subcontracting, G&A-was C$661,000. Of course if the principals

sell some of their stock into the market they can finance the company at

these levels before it runs out of cash. I wouldn't, but maybe they will.

Will Polyphalt become a gigantic success? I wish it well, and perhaps it

can pull this off; anything is possible, and the deal seems legit. But that's

got almost zero to do with its actual prospects. I'm betting that even in

the unlikely event that it's wildly successful, the shares will be available

in a few years for a fraction of their current price. But the thought is

irrelevant, because the current market cap of US$60 million (based on 8.3

million outstanding shares) is discounting huge success, with no allowances

for the reality that 99 out of 100 deals that are at least this good go to

zero. Even those that actually have cash and revenues.

In any event, the reason the stock has already gone 10-1 is based totally

on newsletter-driven buying. As subscribers fall off, take profits, or get

bored, there will be more selling, and no new buying-entirely apart from

what a bear market will do.

I shorted a few thousand shares when I first heard the story. I think you

might consider it as well. But be advised that you could have a religious

experience if this thin stock is touted again, regardless of its likely

long-term fate.

If you decide to join the party, call the company to be put on its list for

press releases (416-978-6588).

 

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POST MORTEM

The price of Polyphalt subsequently collapsed to C$x by xx, so the returns

on the short were fairly spectacular. Since then it's been trading about

C$x. The company has had to sell x million extra shares to stay in business

since then. Would I look to buy it here? No. Maybe it's worth looking at if

it turns in a dozen consecutive quarters of growing revenues and earnings--

presuming it ever shows earnings.

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