Short-sellers likely pounded in run-up of Station stock

David Strow

Tuesday, Jan. 29, 2002 | 11:09 a.m.

Jan. 16 was a day to bring smiles to the faces of long-suffering Station Casinos Inc. investors, as the Las Vegas company's stock soared after a prominent analyst turned bullish on the stock.

But for investors who had sold Station short, the day was a painful one. And in the end, a scramble for cover by these investors likely helped propel Station even higher for days after the upgrade.

"It's logical to assume that played some part in the move up," said Dave Ehlers, chairman of Las Vegas Investment Advisors. "With the stock up two points and change ... somebody, somehow, lost upwards of $16 million."

A short sale is an investment designed to profit from a stock's move downward. In a short sale, an investor borrows shares from a broker and immediately sells them into the market. Later, the investor "covers" the short by buying back enough stock to pay back the broker.

If the share price falls in the meantime, the investor keeps the difference. But losses can be unlimited if the share price soars.

In 2001, shorting Station stock was often profitable, as the stock finished the year down nearly 23 percent.

A huge short position had built up in Station stock by the time Harry Curtis of Robertson Stephens upgraded Station from "hold" to "strong buy." As of Dec. 15, more than 8 million shares had been shorted by investors. That's more than 14 percent of Station's outstanding shares, and nearly one-quarter of Station's "float," or shares available for public trading.

That was the highest short position in any publicly traded gaming company as of Dec. 15. Mandalay Resort Group was the next closest, with 13.3 percent of its float sold short.

In his research note, Curtis outlined the reasons so many investors would be willing to bet against Station.

"Given several dilutive deals, slowing growth of the Las Vegas economy, and the negative impact of 9/11's terrorist attacks, sentiment on (Station) is terrible," Curtis wrote, saying Wall Street was "universally uninterested in or hostile toward the stock."

But as most of the negatives were already priced into the stock, that could spell a buying opportunity for investors, Curtis wrote.

In his note, Curtis said he expected Station to begin beating analyst estimates in 2002 -- and that Station's future earnings per share should justify a share price of $19.50. Curtis had expected Green Valley Ranch Station Casino to steal away about 25 percent of Sunset Station's profits, but he now believes cannibalization will reduce Sunset's cash flow by just 10 percent.

Moreover, Curtis wrote, demand for Green Valley Ranch appears higher than expected, and Palace Station is losing little business to the nearby Palms hotel-casino.

"As results are reported ahead of consensus, aggressive short covering would be a powerful catalyst for the stock," Curtis wrote.

But the research note itself -- and the subsequent reaction of the markets -- may have triggered that short covering. Station rose more than 18 percent on Jan. 18 to $13.72. The next day, it gained another 5.5 percent to close at $14.50. Nearly 3 million shares traded on those two days, compared to average daily volume of 270,000.

Even if they believed the rise in Station stock would reverse itself in the coming days, short investors often don't have the ability to ride out a rise in share price, Ehlers said, because short selling must be done with a margin account.

When a share price rises, a short-seller will see the amount held on margin increase, because of the difference between the short sale price and the market price. Since investors must maintain a certain ratio of margin to equity held in their accounts, this can force them to cover their shorts at a loss.

"If you have a strong recommendation like that, that drives the stock upward, you could conceivably get yourself into margin pressure," Ehlers said. "If you start losing money on a trade, it decreases your ability ... to finance your position."