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The collapse in the share price of Poseidon Concepts Corp. has produced at least one winner, supporting the adage that it's an ill wind indeed that doesn't blow someone some good.
In this case, the good accrued to LDIC Inc., a small Toronto-based money manager that had been resolutely shorting the stock for much of the past year. It was one of the few bears in an investment community that had been almost uniformly bullish on the prospects for Poseidon, a maker of storage tanks for fluids used in fracking, the hottest recent story in the natural gas industry.
Poseiden shares tanked almost 70 per cent to close at 27 cents in heavy trading on the Toronto market Thursday, following revelations by a special committee of the company's board that most of its revenue for the first three quarters last year didn't exist, vindicating LDIC's negative assessment.
"I think this was really a triumph of diligent research work up against a company that, for whatever set of reasons, were not really reporting in a transparent way," said Michael Decter, president of LDIC. The firm made about $1.2-million in the trade, spread over three mutual funds it advises.
The coup by LDIC is all the more remarkable because investment analysts had been big boosters of Poseidon. Up until last May, all of the approximately 10 analysts who were following the company had "buy" recommendations. Many target prices were around $20. Poseidon, cresting in the glow of these positive reviews and demand for fracking investments, had a market value last year of more than $1-billion, although its capitalization has since crumbled to about $23-million.
In a short sale, an investor borrows shares from a broker and sells them, hoping to profit by betting the share price will decline before the investor must return the borrowed shares. The trade is the reverse of buying a stock and trying to profit from an advance.
What twigged LDIC to Poseidon's poor prospects, when most of the Bay Street investment crowd didn't notice that much of the company's stated revenues didn't exist?
Poseidon said in a statement Thursday that $95-million to $106-million of its $148.1-million in revenue for the nine months ended Sept. 30, 2012, should not have been recorded as revenue in its financial statements.
Mr. Decter says reports that Poseidon's profit margins were around 90 per cent aroused suspicions in his firm that such lush returns couldn't possibly be sustained. Storage tanks were an industrial commodity and would attract competitors, shrinking its profitability, was the reasoning at LDIC.
"People like the tanks, but we did a lot of work and we felt that the rental prices would drop dramatically, which they did. We also felt there were a lot of potential competitors," Mr. Decter said.
To fully understand the challenges facing Poseidon, LDIC talked to both customers and competitors.
Short selling isn't for the faint of heart because the trade has unquantifiable losses if a stock advances. What is more, short sellers have to pay any dividends a company declares and an additional fee for borrowing the stock. In the case of Poseidon, these costs ranged from 10 per cent to 25 per cent during the time that LDIC was short, according to Mr. Decter.
After LDIC initiated the trade at $14, the shares remained elevated.
"It required a very strong stomach," Mr. Decter said of maintaining the position. "But we were very convinced, my trading room team, were very convinced that the numbers weren't what they appeared and we were eventually vindicated."
The firm wasn't short the stock on Thursday because it had previously covered its position at a big profit at around $1.50 a share. "We try not to be greedy in these things," Mr. Decter said.