7 Stocks Under Attack

Since everyone loves a winner, it's reasonable to assume that everyone hates a loser -- everyone but short sellers, at least. These contrarian investors bet that hot stocks are primed to fall, aiming to turn their pessimism into potential profits.

This week, let's look at companies on the American Stock Exchange with the largest numbers of shares short. We'll then consult the collective intelligence of Motley Fool CAPS to see which of these firms Fools believe have the power to make short work of short sellers.

Of course, this isn't a list of stocks to buy -- or short! These stocks could have serious problems that warrant their short interest, but they might also be stricken by short-term troubles. Only Foolish due diligence will tell you for certain; our 84,000-strong CAPS community just offers a good place to start. Yet most of these companies are generally well-liked -- they've garnered three stars or better on their CAPS ratings.

Feeling the squeeze
Watching a video on YouTube is like eating a sausage; you don't think much about what goes on behind the scenes. You'd probably rather not know what goes into your spicy links as long as they taste good, and you probably don't care exactly what technology allows you to watch a video of what happens when you mix Mentos with Diet Coke. Yet companies like On2 Technologies not only care, they are the technology.

You might be more familiar with QuickTime or RealPlayer, but it's On2's TrueMotion VP video-compression technology that was behind the fairly ubiquitous Flash player from Adobe (Nasdaq: ADBE). The company doesn't have the same name recognition as some of its competitors, but On2's proprietary technology is on display everywhere.

In part, that was both the opportunity and the risk here. Because Adobe has a strong platform in the Flash player, On2 was able to achieve a modicum of success. Yet its codecs (compression / decompression algorithms) are proprietary, meaning the chance to lose business or be shut out of opportunities was great, since customers could opt for the standard compression specs of MPEG-2 or H.264. And that's just what happened late last year, when Adobe announced that the newest version of its Flash player would also carry H.264 specs.

On2 has always been something of a speculative stock, and it was the limited nature of its portfolio that had top-rated CAPS All-Stars like Gibybo betting against it last April:

They have a strong product with great potential. However, the market seems to have figured that out already. It's one product and I think their competitive moat is far too small to justify the hype.

In a reply to Gibybo's post, CAPS player mysoftballcoach pointed out last August the Adobe development that he thought would make On2 irrelevant:

Word out this week that Adobe will be switching their video codec to H.264 in the Flash Player 9. An Adobe Blog mentioned they did not know if they would be supporting VP6 (ON2's codec). At this time, they did not have VP6 compatible with H.264 and did not know if they could make it compatible. If that is the case, it will render ON2's products, such as Flix Encoders, Flix Decoders, virtually irrelevant. Add to this, they are about to issue millions of shares to purchase Hantro, a company that has never shown a profit. Looks to me like stormy seas are just ahead.

Stormy, yes, but Hantro does offer H.264 codecs, so On2 just might be able to expand its offerings at a time when the industry is looking for more choice. It was that choice that allowed Infineon Technologies to choose On2's Hantro video accelerators for chips designed for mobile handsets.

Speak up
You've heard from CAPS investors -- now it's your turn to have your say. Share your views with the CAPS community: Squeeze 'em till it hurts, or short 'em till the sun don't shine? May the best argument prevail!