Expensive Shake Shack short bets may have paid off

[August 22, 2015]  By Noel Randewich
 
 SAN FRANCISCO (Reuters) - Investors short-selling Shake Shack Inc <SHAK.N> may have made money over the past week, even after paying exorbitant interest rates to borrow the stock.

The fast-casual burger chain's Aug. 10 quarterly report beat Wall Street's expectations, but that was not enough to prevent a slide in the stock, which had traded at sky-high valuations since its January IPO.

In a week when the S&P 500 lost 5 percent over three days, Shake Shack's example shows that sophisticated investors can profit in down markets but often do so at a high risk.

Since its initial public offering in January, Shake Shack has been wildly popular with Wall Street and with consumers, who wait in long lines for its indulgent hormone- and antibiotic-free burgers and sides. The stock surged over 300 percent in four months, but also attracted skeptics betting its shares would reverse.

Short sellers borrowing record numbers of Shake Shack shares have created a shortage, driving up borrowing costs to unusually high levels that make it more difficult to profit from a decline in the stock and riskier to bet against the company.

The annual interest rate short sellers paid to borrow Shake Shack shares was an exceptionally high 210 percent on Monday before moving down to 50 percent by Friday, according to SunGard's Astec Analytics, which tracks securities lending.

Investors borrowing Shake Shack shares at Monday's interest rate and selling them at the day's closing stock price would have paid $1.29 in interest to maintain their bet through Friday at mid-day, when they could have bought them for back for $7.08 less than their selling price, for a profit of $5.79 a share.

It has fallen 47 percent from its May record high and short sellers may have recently taken profits, with the stock falling 30 percent since August 10.

The dip in borrowing costs since Monday also follows an additional 4 million shares hitting the market after a secondary offer from insiders completed this week.

"The already ‘oversubscribed’ demand meant that utilization of this new stock available to lend held near the 100-percent mark even as volumes climbed during the week," SunGard analyst Karl Loomes said in an email.

The interest rate paid to borrow shares tends to rise in line with demand from short-sellers, who borrow and sell stocks they think will fall in value, hoping to make a profit by buying the stock back more cheaply later on. A significant percentage of stock in a short position indicates that investors expect a stock to drop in value.

But paying a high interest rate makes shorting the stock extra risky and can force investors to cut their losses and buy back shares if the stock moves higher.

Shake Shack's stock is now trading at a lofty 177 times expected earnings, compared to 38 for Chipotle Mexican Grill <CMG.N>.

At end of July, investors were shorting a record 2.4 million Shake Shack shares, equivalent to 6.7 percent of its outstanding stock, according to Thomson Reuters data. That was up from 2.2 million shares a month before.

(Reporting by Noel Randewich; editing by David Randall and Nick Zieminski)

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