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January 2, 2012

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Small Cap MLPs Beware: Short Seller Takes Down Stonemor

The most public take down of a company by a short seller this year was when David Einhorn of Greenlight Capital outlined his short position in Green Mountain Coffee Roasters (as discussed in this interview with Reuters here).  Einhorn built his short position, then went public with his short case when the stock was at $92.09 on October 14th (after peaking at a closing price of $111.62 in early September).  Green Mountain had disappointing third quarter earnings, and finished the year with a price of $44.85.
A lesser known public short campaign played out this week for a largely misunderstood MLP that has a loyal following: StoneMor ($STON).  STON owns and operates cemeteries and funeral homes.   STON has a rollup strategy in a very fragmented industry, which has allowed the partnership to consistently buy assets at less than 5x EBITDA, a very attractive multiple that MLPs operating more traditional energy midstream businesses can’t find.
There is a GAAP accounting issue that causes STON to look worse than it is on a cash flow basis, related to the timing of pre-need services sold.  STON carries a 10% yield, has never cut its distribution, has actually raised its distributions per unit each year since it went public in 2004 (averaging 1.8% annual distribution growth last 3 years)
STON has had a rough year end.  Since closing at $28.89 per unit on November 29th, STON has dropped 18% to finish the year at $23.45.  S&P downgraded some of STON’s unsecured debt on November 29th, citing cash flow issues and the need to issue equity to fund distributions.  That caused the initial dropped, which STON was attempting to recover from when an article was published on Seeking Alpha by Brian Harper, who manages a small hedge fund and asset management firm ($16 million of assets as of December 2010, according to SEC filings).  That seemed to cause the 5.8% drop on Thursday this week, and the overall 9.5% drop this week.

The article Brian wrote can be found here on Seeking Alpha.  He says STON’s issues go beyond the nuances of their accounting for pre-need services.  He highlights that coverage ratio has declined, management has watered down the definition of distributable cash flow, equity issued appears to be funding distribution growth and founding management cashed out in the February stock deal.  While certainly some of those things are true, others are debatable.  This rebuttal article by Jens Heycke does a nice job of explaining some of the confusion.
Who knows how long Harper has been short.  Maybe he’s been short since the news broke that S&P’s announcement on November 29th, and STON’s upward trend since the initial drop wasn’t working for him.  Maybe he was in desperate need for some returns heading into the end of the year, and built a short position, then published the article.  However long he has been short, the gameplan worked.  STON’s complicated operations adds confusion to what would ordinarily be an obvious hit piece.
It’s always amazing to me that people own an MLP without understanding how the business works.  If you own STON and it was news to you that STON issues lots of equity and when looked at on a PE basis it will look more expensive than its peers, maybe it makes sense for you to sell.  The investors that like STON are the long term types that like it when weak hands sell, giving them an opportunity to buy more stock at the right time: when its on sale.  I don’t own any STON, but have met with management and they seem credible.  There may be some risk and red flags out there to some, but that’s why STON carries a 10% yield, and not a 7.5% yield.
What interests me about this week’s action going forward is how well it worked, because its likely to be tried again on other small cap MLPs with light volume and thin research coverage.
It has never been easier or cheaper for short sellers to execute smear campaigns on companies they are short.  Seeking Alpha, Stocktwits, message boards and blogs are all hungry for ideas.  If you write an article and submit it to Seeking Alpha without enough “actionable” ideas, it will not get published.  To get published, you throw an idea out there, even if you (a) don’t know what you’re talking about or (b)  are deliberately confusing people and trying to get people to sell, an idea is an idea.  If the idea is controversial and leads to a bunch of comments from people saying the author doesn’t know what he’s talking about, even better (more page views!).
The sad part is that for MLPs there are so few sources out there with opinions about thinly traded MLPs, that even some random guy with a small fund and a short pitch gains traction and moves the market for a stock.  As more people start to discover MLPs, I expect what happened to STON to become a trend going forward, creating opportunities to acquire small cap MLPs on sale in the future.
Disclosure: The information in this article is not meant to be financial advice, we are not your financial advisor and I am posting my comments for informational purposes only. 

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