Last Friday brought to a close one of the strangest trading weeks ever witnessed on Wall Street. This was due to the irregular activity by hedge funds, a small number of which were wiped out, while numerous others were frozen, and most were instructed by the banks to immediately close risky positions. One New York trader joked that hedge funds make money 364 days of the year, but end up returning it all plus extra on the one bad day when the hedging formulas don't work. Since short positions have been a favorite with the hedge funds ever since the bubble burst, especially those on mid-sized and small stocks, the crisis they found themselves in forced them to close those positions, meaning to buy large numbers of small stocks. So while the "Fear Index" hit new highs last week, it was the small cap Russell 2000 Index, which is perceived as one with considerable risk, that paradoxically, had the best week recent months, closing up 4.4% for the week.
The hedge funds' jitters were clearly in evidence during the course of the trading on Thursday in Omrix Biopharmaceuticals Ltd. (Nasdaq:OMRI), one of the stocks in my portfolio. For some time now, the word on the market was that Omrix's second quarter results would be poor, and that its full year guidance would also be lower than expected.
For hedge funds this was easy prey, since Omrix's value had, from the outset, been inflated on the basis of hopes for an excellent performance, but one that would be delayed until 2008, once the US Food and Drug Administration (FDA) approvals due at the year end come through, or to the beginning of 2009. Massive sales by hedge funds in July lifted Omrix's short interest by 125% to 1.8 million shares, after climbing 66% in June. According to the average daily trading volume in the stock in recent months, it would take five full trading days to cover a short position this high. Omrix did indeed disappoint when it unveiled its second quarter results after the bell on Wednesday, and also lowered its guidance for the rest of the year. The stock gave up 20% in after-hours trading and the hedge funds were hoping to cash in big time when normal trading resumed on Thursday.
Omrix's investors could hardly believe their eyes when the stock, which should have lost up to 20%, ended Thursday up 2% on massive volume of 2.5 million shares. On the one hand the hedge funds were scrambling to buy shares in the hope of locking in a whopping short profit, but on this occasion, because of their situation on the market, they were the ones in a panic. On the other side were regular Omrix investors who listened to the analysts. Most of them did not offload their shares at end-of-season prices, which is why the stock made its surprising rebound at the end of Thursday's session.
The person who played a key role in stopping the short funds from making a fat profit on Omrix's poor results, was the analyst covering the company, Matthew Dodds of Citigroup. Just two weeks ago, he added it to Citigroup's list of recommended small and mid-size stocks for the coming year, so last Wednesday's disappointing results and lowered guidance couldn't have come at worse time for him.
Dodds was certain that in the aftermath of Wednesday's bitterly disappointing results, Omrix would open the day at $24, down from $30 at the close of trading on Wednesday, before the company's results, so he urged investors to buy it aggressively. Dodds lowered his target price by just $3 to $42, since he believes that it will record earnings per share of $1.51 in 2008, on sales which he expects to reach $85 million, compared with the $56 million he expects for 2007. Dodds bases his optimism on a number of Omrix products, but principally on the FDA approval for its Thrombin-based product for the prevention of hemostasis in surgery, an approval which he believes will be forthcoming in its next meeting scheduled for September 6. Omrix will bring its Thrombin product onto the market during the fourth quarter, once the FDA approval has been given, and its distributor, Johnson & Johnson Inc. (NYSE: JNJ) subsidiary Ethicon Inc. will begin selling it, with the aim of gaining a significant share of the Thrombin product market, estimated to be worth $270 million a year.
Gilat under pressure
Another company to feel the heat from the hedge funds when it published its results last Thursday was Gilat Satellite Networks Ltd. (Nasdaq: GILT; TASE: GILT), although in its case, the position was not short but the reverse. Gilat is currently making headlines, and has been climbing strongly following rumors that it could soon be sold, although this will be precious little help to a hedge fund from Boston called Sowood Capital. It made a smart move when it picked up 6% of Gilat, 2.44 million shares, at the end of 2006 and the beginning of 2007, and it should have earned a tidy profit from the company's recent results, and from what is shaping up as a battle to acquire control of it. Sowood reached the end of the road two weeks ago, after losing $1.5 billion in July, 50% of its value.
Sowood was founded by Jeff Larson, a well-regarded investment manager, who previously worked at Harvard University's investment arm Harvard Management Co. where he managed the institution's foreign equity investments. He managed, over the years, to deliver very good returns on the university's funds, but his mismanagement of his own fund resulted in it being swiftly wiped out. He transferred its remaining investments, including the Gilat shares that he didn't get around to selling when Sowood crashed in July, to a larger and better known fund in Chicago called Citadel, which duly announced at the beginning of this month that it was now a party at interest in Gilat with 2.1 million shares.
It now appears that the southbound pressure on Gilat's stock in recent weeks was due solely to the sale of 700,000 shares by Sowood alone, since Citadel already held 400,000 shares of its own. Last Thursday, when Gilat unveiled its second quarter results, Citadel capitalized on the investors' excitement at the company's excellent results, and sold a large part of its holding, sending the stock down slightly, but on a large volume of 1.3 million shares.
Published by Globes [online], Israel business news - www.globes.co.il - on August 14, 2007
© Copyright of Globes Publisher Itonut (1983) Ltd. 2007