These Underdogs Will Fight

01/30/2012 1:22 pm EST


Igor Greenwald

Chief Investment Strategist, MLP Profits

Beaten down stocks backed by insiders have outperformed of late. Here are two more short-squeeze candidates, writes senior editor Igor Greenwald.

A bit of successfully negotiated recent adversity can be an asset, for companies as well as people.

It means management as well as the stock have been tested under fire. Investors have been hardened, and are less likely to desert at the next whiff of trouble. The shorts have had a chance to pile in and then feel some pain.

The last four months have been all about such comebacks, and so far this year nearly every underdog and mutt has had its day. The trick then is separating the contenders from pretenders. I’ve been looking of late for heavily shorted stocks with strong present-day fundamentals, favorable secular trends, and skilled, committed insiders.

United Rentals (URI), profiled Friday, qualifies. So do today’s speculative candidates, the investment-banking boutique Greenhill (GHL) and American Public Education (APEI), an online for-profit university.

Each has been tested and proven its mettle. Both remain heavily shorted. And both have seen insiders put their money on the line of late.

Greenhill was founded 16 years ago by Robert F. Greenhill, the longtime Morgan Stanley (MS) veteran from a bygone Wall Street that used to advise clients so as to retain their loyalty, instead of ripping them off in crooked deals.

Greenhill still holds to that model, and therefore faces fewer conflicts of interest and regulatory risks of the sort weighing on Morgan Stanley and Goldman Sachs (GS).

For all the vagaries of its business, it’s held its quarterly dividend steady since 2008. The current yield is 3.6% and the CEO has recently said he’d have to be waterboarded to cut the payout.

Despite a stinging setback when client AT&T (T) was forced to abandon its proposed acquisition of T-Mobile, Greenhill recently posted strong results. Despite the death of a key investment banker in December, the stock has rallied 38% since mid-December, after performing worse than every midcap financial last year.

Short interest remains high, at nearly 18% of float and two weeks’ of trading at the recently elevated daily turnover. In mid-November, director John C. Danforth, the former Missouri senator, bought shares worth nearly $200,000 at 23% below the current price.

The stock is hardly cheap at 23 times this year’s estimated earnings, but could look cheaper if companies with swollen cash reserves pick up the pace of strategic acquisitions. The high short interest leaves plenty of room for a short squeeze if Greenhill continues to deliver.

Meanwhile, American Public Education is a small-cap, for-profit university operating exclusively online, catering primarily to active-duty military servicemen as well as veterans. Popular degree programs include public safety and health, security and global studies management, and business.

That focus on active-duty military has been both a blessing and a curse. On the plus side, it has allowed APEI to continue to grow rapidly at a time when most of its rivals have been victimized by the economy and increasingly tough federal regulation. Revenue rose 35% during the most recent quarter. The no-frills strictly online model boosted operating income 61% even as APEI’s tuition remained well below that charged by competitors.

The downside is that APEI remains uniquely vulnerable to Pentagon efforts to reduce its spending on benefits. Shares plunged as much as 28% intraday this fall after the Marine Corps, the leading employer of APEI’s students, cut its tuition-reimbursement allowance. And though the cut was quickly reversed, the company acknowledges that further cuts are likely.

Even if the military retrenches, though, the soldiers may be able to get additional aid under the GI Bill. And as the Armed Forces shrink in the wake of two decade-long Asian wars, more veterans may enroll as a stepping stone to a new career.

After rallying strongly in November and December, the stock has pulled back of late, perhaps in response to the latest attempt to limit the recruitment of military personnel by for-profit schools. A similar attempt failed last year. The recent history of the for-profit sector is checkered with nasty regulatory threats, most of which have ended up getting watered down significantly.

Director Timothy Weglicki is certainly a believer in the power of a low-cost education, having plunked down $12.6 million on APEI shares in November at a 10% discount to the price today.

Weglicki isn’t just some chump—he’s the founder of a private-equity shop who serves on a half-dozen boards, including that of Coventry Health Care (CVH). He’s likely to be better informed than the shorts who have borrowed 14% of the stock’s float, equivalent to more than two weeks of current turnover.

APEI shares sell for nine times trailing cash flow, not bad given its the recent 40% compounded growth rate. Online learning remains the most promising part of the bloated higher education sector, and few groups will need as much of it in the near future than members of the military, who will retain generous backing from Uncle Sam even after the inevitable cuts.

Like its many of its students, APEI is battle-hardened. The shorts betting against it? Not so much.

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