SmileDirectClub ( SDC -9.37% ) is one of the most heavily shorted stocks on the market. Approximately 37% of the teledentistry company's shares were sold short at the end of September, causing it to become one of the most talked-about stocks on Reddit's WallStreetBets subreddit.
SmileDirectClub went public at $23 per share two years ago, but its stock immediately sank below its offering price. Today, it's only worth about $5. Should investors consider buying this beaten-down stock as a short squeeze candidate?
What happened with SmileDirectClub's IPO?
SmileDirectClub produces 3D-printed clear aligners. Unlike traditional braces, clear aligners can be easily removed and are difficult to see, making them a popular choice for many consumers. SmileDirectClub conducts most of its business online. Customers receive an impression kit at home to create a dental mold, which is then sent back to the company and examined by orthodontists to create the final product.
SmileDirectClub's growth looked impressive at the time of its IPO in Sept. 2019. It has served over 700,000 members across the U.S., Canada, Australia, and the U.K. since its founding in 2014, opened more than 300 brick-and-mortar SmileShops to complement its online business, and secured in-store partnerships with CVS and Walgreens.
Its revenue surged 190% to $432.2 million in 2018, and rose 113% year-over-year to $373.5 million in the first half of 2019. But it also faced two problems. First, it was unprofitable and its losses were widening. Second, it had just settled an ugly legal dispute with its former partner, the clear aligner maker Align Technology ( ALGN -0.83% ), six months before its IPO.
Align was initially SmileDirectClub's exclusive third-party distributor, but emerged as a competitor by opening its own retail stores and violating its non-compete clause. SmileDirectClub won the legal battle and Align was forced to sell its 19% stake in the company below market value -- but that dispute heralded Align's arrival as a major competitor.
Why did SmileDirectClub's stock plummet?
SmileDirectClub's growth over the following two years failed to bring back the bulls. Its revenue rose 77% to $750.4 million in 2019, but its net loss widened from $74.7 million to $114.5 million.
In 2020, its revenue declined 12% to $656.8 million due to COVID-19 headwinds, but it narrowed its net loss to $78.4 million as it spent less money during the pandemic. In the first half of 2021, its revenue rose 23% year over year to $373.6 million as some of those pandemic-related headwinds waned. It also narrowed its net loss from $56 million to $45.8 million.
For the full year, it expects its total revenue to rise 14%-22%. It noted that while "macroeconomic trends persisted into July 2021 from a demand perspective," its business can still be "highly variable on a month-to-month or quarter-to-quarter basis." It didn't provide any bottom-line guidance, but analysts expect it to stay unprofitable for the foreseeable future.
SmileDirectClub's numbers weren't terrible, but they clearly disappointed investors who had expected higher growth rates. It also generated much lower sales than Align, which raked in $2.1 billion in Invisalign clear aligner sales in 2020. It also faces tougher competition from Dentsply Sirona ( XRAY 2.61% ), a larger dental equipment manufacturer that bought out SmileDirectClub's smaller competitor, Byte, this January.
A series of negative headlines also battered the stock. The company faced ongoing criticisms and complaints from the American Association of Orthodontists, and it was hit by a class action lawsuit from customers over allegations of false advertising shortly after its IPO. Earlier this year, it was hit by a cyberattack, and a court invalidated one of its clear aligner patents in a dispute with its competitor Candid Care.
Align also successfully sued SmileDirectClub to recoup the full value of the stake which it was forced to divest in 2019. The new ruling, which was passed in March, requires SmileDirectClub to pay an additional $45.5 million plus interest to Align for the value of its original investment.
Why do investors think a short squeeze could happen?
SmileDirectClub's flaws are easy to spot. Its growth is decelerating, it faces intense competition, and it still can't generate a profit even though a single treatment costs $1,950 when paid up front.
But unlike many other meme stocks, SmileDirectClub still has a growing business. Its number of cumulative members has more than doubled since its IPO to over 1.5 million, and it recently expanded into France, its seventh European market, to further reduce its dependence on the U.S. market.
Its losses are also gradually stabilizing, and its stock seems cheap at less than three times this year's sales. Furthermore, analysts expect the company's revenue to rise 21% next year as its business stabilizes and the macro headwinds wane.
Should you buy SmileDirectClub?
SmileDirectClub isn't doomed yet, and its stock could generate big near-term gains as the short sellers cover their positions. However, I can't consider it a viable long-term investment unless it significantly narrows its losses and widens its moat over the next several quarters.