Roku's (NASDAQ: ROKU) third quarter was good, but not this good. Shares have now more than doubled in the three trading days since Roku's first earnings release as a public company. It's also not as if there has been a string of other positive news, other than an announcement today that Japan's Funai Electric, which makes TVs under the Philips brand, has joined Roku's TV licensing program and will soon integrate Roku's TV streaming platform. That's undoubtedly good news, but probably not worth the $925 million that Roku added to its market cap today.
Is a potential short squeeze -- in which short-sellers buy back shares -- what's driving the gains?
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The case for a short squeeze
It's always hard to say for sure if a short squeeze is occurring, but here's what we know.
Roku's capital structure includes 18.1 million Class A shares and 79.7 million Class B shares, the sum of which determine Roku's $4 billion market cap. But only those Class A shares trade publicly, while Class B shares are held by insiders and convert to Class A once the insider wants the sell. Besides, those Class B shares are all bound by lock-up agreements for six months following the IPO, according to the prospectus.
The float is what matters here as it relates to price fluctuations, and we can say Roku's float is less than 18.1 million shares. MarketWatch estimates Roku's float at 15.7 million shares. At the same time, there were 4.8 million shares held short at the end of October, so short interest represents a whopping 30% of float.
Days to cover at the end of October was about 2.4 days, which suggests that it would theoretically take that long to cover all short interest if all trading activity was covering short positions. However, that was based on average daily share volume of 2 million shares, while volume over the past three days has averaged 40.1 million shares, rendering that days-to-cover figure less meaningful.
Shares are still considered hard to borrow, and on Friday borrowing costs were around 20%. I just inquired with my broker-dealer again near the close and was told to expect borrowing costs tomorrow morning to be approximately 25%, so the costs associating with maintaining a short position are still fairly elevated. Borrowing costs are quoted as an annual rate.
Is a pullback in store?
The important thing here is that if a short squeeze is indeed occurring -- which could be confirmed once the next official short interest figures are released if shares held short falls meaningfully -- then the gains are not being driven by fundamentals. As such, the gains may not be sustainable if shorts are just temporarily pushing shares higher as they cover their bearish positions.
For prospective investors that could be interested in buying in, it might be worth waiting to see if prices pull back. As stretched as the valuation looked before, shares look that much more expensive after the past three days. The stock nows trades for over nine times sales at this point -- for a company that still has meaningful hardware operations. Media players still comprise two-thirds of revenue, even though the platform is the real money maker.
Investors should always exercise caution when a stock puts up these types of gains in such a short period of time, and Roku is no different.
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