It just doesn't pay to short a cash-rich company trading at a low price-to-free cash flow multiple.
Just ask short-sellers of Websense (NASDAQ:WBSN), which surged 28% today after the company issued an upside preannouncement last night. With 21% of shares in the hands of short-sellers, today's move was clearly amplified by the buying pressure of shorts scrambling to cover their positions -- a classic short squeeze.
The shorts' critical mistake was a failure to consider Websense's dirt-cheap valuation. At yesterday's $15.62 close, the stock was valued at just 9.7 times free cash flow. If you back out excess cash of $6.94 per share, Websense's free cash flow multiple at yesterday's close was just 5.4. Shorting a stock this cheap is financial suicide.
The Websense short thesis also failed to appraise the strength of the business. Shorts had counted on increased competition to drive down margins in the Internet-filtering software space. It was thought that Websense's premium pricing ($14 per seat versus competitors' $9 to $10 per seat) would come under pressure, which would in turn hinder revenue growth.
Hardly. For the quarter ending in June, management now expects revenue of $19.4 million to $19.6 million, comfortably above the consensus analyst estimate of $19.3 million. This represents 5% growth over the first quarter and 33% growth over the year-ago quarter. Apparently, Websense's software has some type of advantage -- possibly its industry-leading installed base? -- that justifies its higher prices.
(Tom Gardner presumably knows all this; after all, he recommended the stock to subscribers of the Motley Fool Stock Advisor.)
If you ask me, the only thread of hope for the shorts is the continued selling by Websense's top management. Just last week, the CEO and CFO each disposed of their remaining shares obtained through past option grants. While this type of selling puts a damper on investor confidence, this just goes to show that financial results and valuation are what really count. Insider buying and selling can only be considered as corroborating evidence.
Matt Richey has no beneficial interest in Websense.
