Short Sellers Circling Square

It’s a truism on Wall Street that when a stock moves up and to the right, sharply, posting strong gains in a brief time — the short sellers begin to salivate.

So it is with Square, the payments tech outfit that initially came to market with an underwhelming IPO pricing that was far below initially disclosed ranges, but whose shares have rocketed up since then.

‘The stock now trades at $12, well above the initial $9 offer but down quite a bit from the highs of nearly $15 seen in its short trading life since the Nov. 18 debut.

Short sellers bet on a stock’s descent, borrowing shares and selling them, with the goal of buying them back at a lower price and then pocketing the difference.

Reuters said Thursday that as much as 85 percent of the Square common shares that are available to be lent out via institutional owners have been “snapped up” by short sellers – and they are paying dearly for the privilege, with a 45 percent interest rate – that’s annualized – levied as borrowing costs. Reuters cited data from SunGard’s Astec Analytics service.

The short position itself is a relatively small slice of Square’s stock pool, as the firm sold only about 9 percent of its shares in the IPO.

Still, the fact that “the shorts,” as they are commonly known on the Street, are jumping in this early in the game speaks to rather jaundiced views of the company’s valuation and fundamentals. The valuation question itself has been well documented, with the concerns stoked by the fact that the actual pricing to market, well below the $11 to $13 range, implied that recent funding rounds had overshot the valuation and near term outlook of the company.

The haircut when the shares came to their IPO was a rough 40 percent below previous implied valuations, and some observers chalked it up to the fact that the company has an unusual leadership structure, where CEO Jack Dorsey is also leading Twitter.

And, despite the fact that revenues have been growing at a healthy clip (north of 50 percent year over year), that’s actually a slowing rate from the past, where growth had been more than 60 percent.

Expenses have been trending in lockstep with revenues, which implies red ink for quite a while – and that’s something short sellers love to see. Add in the continued competition from players with extremely deep pockets – Apple, anyone? – and Square might be in for a rough road to growth. That’s also something short sellers love to see: competitive pressures.

For now, it’s still too early to gauge the impact that short sellers may have on Square’s stock price. There simply has not been enough time to see where the shorts as a percentage of the float (that is, shares outstanding that can be freely traded) has trended. The whopping interest charged on the short position speaks to demand, but it also means that when the stock shoots higher, shorts may find it too expensive to hold on to their positions and may scramble to “cover” or unwind them (which can also drive the stock higher).

For now, the short selling likely belongs to a brave bunch testing the waters of a “battleground” stock, and indeed Square has a story that has strong believers and strong detractors. Time, of course, will tell who is right.