Why are short sellers targeting iSentia Group Ltd?

Short sellers borrow shares in a company in order to sell them on market. Because they will have to buy back the shares in order to return them, short sellers are therefore betting that the share price will go down. Academic studies have shown that short sellers are good for the economy, and help spot fraud, but the key question for investors is whether they should avoid shorted companies, or bet against the shorts by buying shares.

iSentia Group Ltd (ASX: ISD) had 11.5% of its shares sold short on the 22nd of May, 2017, with 23 million shares sold short. That’s around 10 times the daily average volume of shares traded during May. That means unless there is some extremely good news, there is unlikely to be a scramble to cover short positions, and we probably won’t see a short squeeze.

One likely reason short sellers are targeting iSentia is that it spent up big on the acquisition of King Content, which turned out not to earn as much money as iSentia thought it would. Once the market found that out, the shares crashed, so it’s fair to say there are plenty of disappointed shareholders. At the time, iSentia CEO John Croll said:

“What probably happened inside the last four months was there were some decisions taken inside King Content around the resourcing of new sales teams and the account management that were taken, in my view, premature to the proper transition across to the iSentia team and that has created a period where we didn’t have a strong revenue pipeline coming into the business…”

The second likely reason short sellers are targeting iSentia is that its legacy core business is not growing particularly strongly, suggesting that it does not deserve a growth multiple. In the past at least, it’s fair to say the market may have overestimated the core media monitoring business.

iSentia has net debt of over $50 million, thanks to the King Content acquisition. This means that it is in a weaker position than it was when it was a smaller company.

While I think Domino’s Pizza (ASX: DMP) makes more sense as a short selling target than iSentia, I would say that iSentia makes more sense as a short selling target than Aconex (ASX: ACX). The main reason for this is that Aconex has a strong balance sheet compared to iSentia. It does not surprise me that short positions on iSentia have been reducing.

After all, based on the first half earnings, the company is only trading on around 16 times earnings, meaning expectations are not particularly high. Therefore, it’s clear that should King Content perform better in the near future — and if the company pays down debt — then it’s likely that there is significant upside from here.

Having said that, iSentia has disappointed shareholders in the recent past. In comparison one of our ‘future blue chips‘ is a fast growing company with plenty of cash. And the company I’m thinking of has a longer listed history than iSentia, and appears to do the right thing by long term shareholders.

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Claude Walker is a Motley Fool investment advisor. He does not own shares in the companies mentioned in this article. You can follow Claude on Twitter @claudedwalker. The Motley Fool's purpose is to educate, amuse and enrich investors. This article contains general investment advice only (under AFSL 400691).

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