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Pegasus Squeezes the Shorts

Management at Pegasus Wireless (Nasdaq: PGWC  ) has put shorts in a very awkward position.

On Aug. 4, the company announced a special "property dividend," which amounts to a common stock purchase warrant at a strike price of $8 for every 10 shares of Pegasus Wireless common stock owned. The catch is that only registered shareholders are eligible to receive the warrant. Investors holding shares with their brokerage in the "Street Name" will not receive the warrants.

Investors who wanted to receive the free warrant needed to call their broker and ensure that their shares were listed under the investor's name, not the brokerage's name. Why is management doing this? Probably because once shares are put in the name of the individual investor, those shares cannot be lent out to short sellers. The effect is that the pool of shares to borrow for short selling will approach zero, and if a brokerage has already lent out shares, there's a good chance those shares will need to be recalled, forcing short sellers to cover at market prices.

Over five million shares have been sold short, and the average daily trading volume is under 500,000. The deadline for brokers to report beneficial shareholders to Pegasus' transfer agent is Aug. 28. Assuming that all investors sign up to receive their free warrants, all those shorts will need to be covered in less than seven trading days. This stock is primed for a short squeeze!

To add fuel to the fire, the company put out a press release quoting CEO Jasper Knabb: "We at Pegasus fully intend to assist our shareholders in holding any broker/dealer that does not comply with the dividend rule liable for failure to deliver the warrants." In other words, Knabb is making it abundantly clear to brokers that if they don't get Pegasus shares away from the shorts, there may be legal action.

I must credit the management team for this brilliant and inventive ploy to boost the stock. I've never heard of another company doing this -- not even (Nasdaq: OSTK  ) , which is famously engaged in a battle with naked shorts. Although I still believe that the stock of Pegasus is overvalued and overhyped based on the fundamental value of the business, I wouldn't want to have a short position at this point.

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Fool contributor Brendan Mathews welcomes your feedback. He does not have a position in Pegasus Wireless or any other stock mentioned in this article. The Motley Fool has a strict disclosure policy.

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