In the last week we have witnessed a few low-float stocks become Ebola speculation targets as the first confirmed case in the U.S was announced September 30th, 2014. It is fascinating to watch these narratives unfold and low-float momentum plays be ignited as pools of capital cohesively and strategically buy-in. Understanding how the market operates, how media cycles affect expectations and how market participants influence each other asymmetrically are key characteristic of understanding the manic-depressive nature of Mr. Market.
First you may be asking what in the world is a Troika. It is a harness used for three horses to pull a sled in the 19th century.
[Figure 1: Troika Example]
What is speculation exactly?
Speculation is: “the forming of a theory or conjecture without firm evidence.”
That is exactly the dynamic that seems to be unfolding over the last few days in the personal protective gear makers, Lakeland Industries, Versar Inc., and Alpha Pro Tech Ltd. When a company trades its entire float a few times in one day, it is a sure sign speculation is brewing. Since Oct. 7th, (eight trading days ago) all three of these companies have risen over 150%+ while the float was traded an exuberant amount of times.
|LakeLand Industries (LAKE)||4.2M|
|Alpha Pro Tech (APT)||14.77M|
In the last eight days Lakeland Industries float has traded 30+ times and the 30-day average daily volume is now 4.86M shares or 120% of the float. The last example of a low-float momentum theme that is quite similar is Digital Ally, a manufacturer of police cameras. Digital Ally had a 2.24M share float and from Aug. 19th to Sept. 2nd (during the Ferguson fiasco) there was cumulative volume of 114 million shares or 51x the float in 11 trading days. The share price during the period went from $3.70 to $33.50 and is currently trading for $10.60 as of this writing.
The narrative at play seems to be Hazmat suits are needed for the Ebola epidemic, there are bagged shorts in these low-float names and there are concentrated hands holding back supply. The media frenzy does not help and the lack of education behind how the disease is spread (direct fluid contact versus airborne) also fuels the fire. LakeLand Industries put out a PR and the president and CEO Christopher J. Ryan explained:
“With the U.S. State Department alone putting out a bid for 160,000 suits, we encourage all protective apparel companies to increase their manufacturing capacity for sealed seam garments so that our industry can do its part in addressing this threat to global health.”
And PCI Global VP went on to say…
“There’s a very short supply around the world. We were able to procure these 276 suits through a medical supply company in California, so we bought them up as soon as we could.” The suits that were procured and shipped were sealed seam garments manufactured by Lakeland Industries.”
So apparently there were only 276 suits available from Lake Land but 160,000 production volume is what is being construed by the market.
The company jumped from 40 million-market cap to 126 million because they sold 276 suits? Unlikely. What is more plausible, is the expectations changed and the market thinks Lake Land will sell 160,000 suits at 6% operating margin (with no CAPEX) using imaginary production capacity. The selling price would need to also be at the maximum of estimates ($10,000 a suit).
In 2014 FY Lake Land Industries had $93 million in sales, a negative operating margin and a loss of just under $4 million. In the last 10 years they have lost a total of about $4 million.
Does Versar even have Ebola exposure or did speculators mess this one up?
When you word search Versar 10-Ks for “health”, “biological”, “ebola” or “disease”, nothing related is returned. Versar purchased a U.K subsidiary, Professional Protection Systems, ltd that services the nuclear industry. The 2014 sales of the company (bolstered by the Olympics says management) were $2.6 million and included in the Professional Services Segment (PSG). Versar grew $35 million in market cap in 3 days as a result. The argument is that Nuclear suits are a substitute product.
ALPHA PRO TECH
· The Disposable Protective Apparel segment consists of a complete line of shoe covers, bouffant caps, coveralls, gowns, frocks and lab coats.
· The Infection Control segment consists of a line of facemasks and eye shields.
These two segments DPA and IC, had combined revenue of $17 million in 2013. The two segments before taxes had earnings of $2.6 million. The company grew $70 million in market cap in the last five days.
These three companies also compete with Kimberly Clark, Cardinal Health, Dupont (Tyvek and Tychem) and 3M, among others. Why didn’t these companies jump 5%+ during the same period (they are all negative since Oct.7th) if they are the most likely beneficiaries of protective equipment sales? Because they do not have a low float and are not easily manipulated.
All of these competitors have much higher production capacity and if Hazmat suit supply was a serious issue we would witness production utilization kick up and suit prices adjust upward in the mean time. These competitors have the working capital to finance the growth of the production capacity and they have the ability to buy any of these speculative companies with less than one quarters income.
I won’t name any names but it is very likely that the same group that was behind pumping up Digital Ally is also behind the pump in these names. I am not here to condemn people for participating in low-float momentum stocks or for orchestrating the rise. What I am doing is shedding light on the fragility of these underlying narratives. Low-float momentum stocks (on the long-side) have 1 similar characteristic each time they run.
1. It is about supply and demand, controlling a large portion of the float prior to the share price running. As controlling hands (or market makers) are aware of their influence they watch and test the supply/demand strategically through “nibbling” and level 2. (as shorts accumulate, covers are harder to find, increasing price volatility). Low floats are easier to control with fewer dollars, hence the role of supply and demand. Shorts end up trapped and a short squeeze commences. There is also a narrative underlying why the product will instantaneously be in very high demand, whether Ebola, police brutality or 3D printing overthrowing large batch manufacturing.
Pump-and-dump and low-float momentum stocks are interesting to study and remind me of 19th century Wall Street with Jay Gould, Jim Fisk, Daniel Drew and Cornelius Vanderbilt during the railroad mania days. What can be learned here is that price volatility in the short-run is a function of supply and demand of the float, while long-term value is created through return on invested capital exceeding the weighted average cost of capital. This is what Benjamin Graham meant when he proclaimed “In the short run, the market is a voting machine but in the long run, it is a weighing machine.”
Ebola won’t disappear overnight and I do want to see the crisis solved as much as everyone else. What will disappear over night is half of the market capitalization of these companies. Which night is up to the market…
Further Reading: A very interesting case study on another pump and dump