Scrappy Money Manager Beats Short Sellers

Battling against short sellers, a fraternity that includes some of Wall Street's savviest market minds, is often a fast step to the investment graveyard. Nonetheless, that's what scrappy money manager Joan Lappin did in January of last year, in what turned out to be a winning effort. Now, she's at it again on the very same stock — Zoltek Companies Inc., a St. Louis-based maker of carbon fibers.

Short sellers sell stocks they do not own, with the idea that they can buy them back at a lower price and pocket the difference. Buying stocks that are being shorted, as Ms. Lappin did, can often lead to losses.

In January 2007, Ms. Lappin, who manages about $20 million of assets under the banner of Gramercy Capital Management Corp., took a stake in Zoltek at around $20 share in the face of a sizable short position.

I remember the circumstances well, having interviewed her at the time of her purchase. In response, one Cleveland money manager who was shorting the stock lambasted me for quoting her on "such a dog." He further predicted that the company — known for repeated disappointing results — was bound for Chapter 11 and would drop to $7 a share before year-end 2007.

He was dead wrong, as Zoltek's stock shot up more than 150% in 2007 to an all-time high of $51.77, and finished the year at $42.87.

Ms. Lappin also turned out to be wrong, however, with an overly optimistic prediction that Zoltek, in its September 2007 fiscal year, would earn between $0.80 and $1.10 a share on sales of between $140 million and $150 million. The actual bottom line was a loss of $0.10 a share on sales of $150.9 million, spurred by a disappointing fourth quarter.

Ms. Lappin, who had been selling Zoltek shares on the way up, disposed of her remaining stake in early January in response to overall market weakness.

In its first quarter, Zoltek once again infuriated Wall Street with disappointing results that sent its stock skidding to the mid-$20s from the mid-$30s.

In response, Ms. Lappin took a new stake in Zoltek after speaking to management and reasoning that the first quarter disappointment — a small revenue shortfall due to an inventory readjustment — was a "temporary aberration." Later, with the shares at about $21, she added to her Zoltek stake after CNBC pushed its viewers to sell the stock. "I think the network created a delicious buying opportunity and a bottom in the stock," she said.

So far, she's been right, with Zoltek shares ballooning nearly 26%, to $26.52, in a difficult market since CNBC's sale recommendation.

Still, the shorts are betting she's way off base, evident from a sizable current short interest of 6 million shares, or 21.9% as a percentage of the floating supply.

"The shorts got killed before and they're going to get killed again," Ms. Lappin said. "A year out, I think you'll see Zoltek back in the $40s." Within three years, she says, it could be acquired at a much higher price than now.

Her bullish fundamental case assumes rapid growth of carbon fibers, including growing usage in autos. Zoltek's fiber is presently used in different parts for BMWs, Corvettes, and Cadillacs.

Carbon fibers can be used in a variety of applications due to their lightweight, high-strength, conductive, and corrosion-resistant properties. Stronger than steel, these fibers are most commonly used in aircraft brakes, but Zoltek has been expanding their use in electricity-generating windmills and in such sporting goods as golf clubs, tennis rackets, and ski equipment.

Other company highlights include the addition of eight new production lines this year, an improving balance sheet with $63.6 million in cash, and the appointment of a new chief operating officer, Karen Bomba, a manufacturing expert who previously held various management positions at Messier-Bugatti USA, a producer of carbon disks.

To our Zoltek bull, it adds up to a surging bottom line, with fiscal 2008 earnings pegged at $1 a share on sales of $220 million. For 2009, she expects $2 a share on sales of more than $300 million. A further jump to $3 a share is considered possible in 2010. "If the stock sold at a price-earnings multiple of 25, you could see it at $75," she said. Her high-flying $1-, $2-, and $3-a-share projections seem pretty flamboyant, but Zoltek's CEO, Zsolt Rumy, gives them some credence, telling me: "We're headed in that direction." He added: "We're looking for sales to increase 50% a year over the next several years and earnings to grow at a faster rate."

He attributes much of that earnings blitz to his expectations of giant growth of carbon fibers. Pegged currently at about $3.5 billion in annual business worldwide, Mr. Rumy says he sees "sales at least doubling, if not tripling, by 2010."

Still, it's hard to ignore flashing red lights from the shorts who raise the legitimate issue of management's tarnished credibility, given Zoltek's steady stream of disappointments.

dandordan@aol.com