MorningWord 8/25/16: Your Main Squeeze

by Dan August 25, 2016 10:05 am • FREE ACCESS

On Tuesday I previewed Workday’s (WDAY) fiscal Q2 results that were reported last night. Regular readers know that I am skeptical of stories like this. Stocks that trade at ridiculous multiples, are massively unprofitable on a GAAP basis and face increasing competition. Here’s what I said on Tuesday:

My View into the Print: With a nearly $16 billion market cap, WDAY trades at 10x its expected fiscal 2017 sales, and despite an expected fiscal 2017 profit of 5 cents, the company is expected to lose $1.87 this fiscal year on a GAAP basis. For those that think WDAY is a takeover candidate, it’s important to note that Oracle (ORCL, one of their largest competitors but also a potential acquirer is likely out of the picture given their recent $9.3 billion offer for CRM provide Netsuite (N), that valued the company at about 10x their expected sales this year. Applying a 30% premium to WDAY from current levels and you get a massively dilutive and expensive acquisition for any potential buyer.

If the company were to be able to buck the trends highlighted by Needham and Noumura and were to beat and raise, then I suspect the stock easily makes new highs on a short squeeze (see the move today in Best Buy and last week in NetApp).

Well the company offered results and guidance that was for the most part worse that consensus, per Bloomberg:

Workday 2Q Rev. Tops Est.; 3Q Rev. View Misses Est. 08/24 16:15
Workday 2Q rev. $377.7m vs est. $372.8m.
• 2Q Subscription rev. $306.2m vs 223.7m y/y
• WDAY up 3.7% post-mkt on 231k vol
• 2Q adj. loss/share 4c vs est. loss 2c
• Sees 3Q rev. $398.0m-$400m vs est. $401.3m.
• Expects 3Q subscription rev. $331m-$333m

Yet as I write the stock is up 5.5% (was up 8.5% when I started writing) and making new 52 week highs. Why you ask? Well, from what I can tell it’s a good old fashioned short squeeze (12% short interest).

Last night I was out with an old friend who was a long time top ranked sell side tech analyst. He has spent the last decade as a long/short equity hedge fund manager. We discussed WDAY. He is short the stock. So are a lot of his hedge fund friends.  But he made an important distinction about WDAY as a short that may be lost on retail investors. He isn’t short WDAY as an original bearish idea on its own. He’s short it against similar companies that he is long and bullish on. The long/short equity game has changed a lot over the last decade or so as hedge funds’ (with their high fee structures) performance and absolute return is measured in terms of risk taken to achieve said return.

This means that most hedge fund managers (those specifically who are NOT the principals of the fund), who have a long bias are forced by their capital providers to essentially pairs trade. Often times their shorts exist to reduce their net long exposure of their most convicted ideas are paired with expensive stocks in their universe, which many others are also drawn to. The end result is often what we have here this morning in WDAY, despite less than stellar results.

On the short side its like a moth to a flame sort of thing as a stock becomes a place for some of these managers to put on a short against other longs. I suspect this was also the case in a stock like (AMZN) or (CRM) over the last few years. Each saw tremendous share gains despite spotty results (until recently). Large hedge funders, the ones with multi-decade track records (the whales) who essentially answer to no one were long and strong, while the minnows who were merely happy to be funded and live quarter to quarter were short these names to offset long exposure. This an over simplification, but the theme is real.

As mentioned above, since starting to write this post the the stock is well off its pre-market highs. That’s another example of the short squeeze in effect. Shorts bid up in pre-market to cover. Longs come in to take profits recognizing that the quarter and guidance was meh and I suspect the stock probably settles in back towards the low $80s at some point, as its unclear who the incremental buyer of the stock is after those results.