PPro: Stock hurt by shorts

David Strow

Wednesday, Oct. 10, 2001 | 10:46 a.m.

In an unusual strategy, the Las Vegas software company PurchasePro asked its investors to help it combat heavy short-selling in its stock -- a move against the shorters typically called a "short squeeze."

In a letter to investors issued publicly Tuesday, PurchasePro Chief Executive Richard Clemmer said the company believes "the current stock price is attributable, in part, to heavy pressure from 'short selling' in the market."

Short selling is a risky bet that a company's stock price will head down, not up. In a short sale, an investor borrows shares of a company's stock and immediately sells them; at a later date, the investor purchases shares of stock to return to the broker, a move called "covering the short." If the stock price has gone down in that time, the short-seller gets to pocket the difference.

"Thus, their interest in our company conflicts with what most of our stockholders want, (which is for) the stock price to increase," Clemmer said.

Short selling activity can cause a stock to move down, because it involves selling the borrowed shares. Conversely, when many short sellers "cover" their positions, stock prices can be driven up by their buying activity.

PurchasePro's stock has fallen from 70 cents on Sept. 10 to 41 cents on Tuesday. On Sept. 10, there were 8.86 million PurchasePro shares that were sold short. That means one out of every five PurchasePro shares that are available for public trading had been borrowed and sold short.

Short selling is likely partially responsible for the sinking stock price, said George Santana, an analyst with Wedbush Morgan Securities.

"That's happened to a lot of stocks since Sept. 11 ... it's definitely a concern," Santana said. "So many stocks were shorted when the markets reopened."

But there are other factors as well, he said.

"Ultimately, what determines your share price are the fundamentals," Santana said. "In the near-term, you can always try to make it difficult to carry a short position. But if revenues go to $100 million a quarter, the shorts will get squeezed anyway."

To squeeze the shorts, PurchasePro is asking investors to take shares held in their brokers' names and re-register them in their own names. It is also asking investors to take PurchasePro shares out of margin accounts and place them into cash accounts. This could dry up the number of shares available for short selling, and force PurchasePro short sellers to cover their positions.

"If your shares are registered in your broker's name instead of yours or if they are held in a margin account, your broker may lend your PurchasePro shares to short sellers," Clemmer wrote.

The strategy of forcing short-sellers to act may be working; this morning, PurchasePro rose 11 cents to 52 cents, a gain of more than 25 percent.

PurchasePro's strategy has been used before. A particularly memorable example Santana pointed to was a similar message sent in April to investors in MicroStrategy Inc., a Virginia software company. MicroStrategy's stock had slid from $15 in mid-January to $2.50 by mid-April.

In an April 19 letter using language quite similar to PurchasePro's Tuesday letter, MicroStrategy called on its investors to re-register their shares or move them out of margin accounts. The squeeze play on short sellers worked -- on that day, trading volume in MicroStrategy exploded, and the stock rose from $2.97 to $5.24 in a single day.

But while the strategy caused a short-term boost in share prices, it did little to arrest the longer-term downward trend for MicroStrategy. The stock price began slowly moving down again, hitting a 52-week low of $1.10 on Oct. 1.

If an investor has PurchasePro shares in a cash account, it's little more than an inconvenience to re-register the shares from a broker's name to the investor's name, said Jeffrey D. Hines, an investment consultant with Futrell Financial Management of Las Vegas.

"But for that to work, many, many shareholders would have to do that, or else there'd be plenty (of stock) for short-sellers to sell," Hines said.

But the situation is far different for margin investors. In margin accounts, investors borrow money to buy shares. The shares bought this way can't be moved out of the account unless the money borrowed is repaid. Margin investors are also required to keep a certain level of stock value in their accounts to balance their debt; if stock prices fall, they can be forced to sell stock to pay back their debts, a move called a "margin call."

Margin calls are something a lot of investors have had to face with the recent stock market fall, Hines said. So the last thing many PurchasePro investors might be able to do is move their shares out of margin accounts.

"If they haven't used the margin available in their account, there's no problem," Hines said. "If they're fully margined, it would probably be very difficult."