Why the ASX's third most shorted stock just fell 20%

Shorters are cashing in on Megaport (ASX: MP1) after the stock tumbled as much as -20% following the release of its December quarterly report.

Megaport has become a prime candidate to short due to characteristics such as the lack of profitability (-$48.5m loss in FY22) and a lofty valuation (trades around 10 times sales).

Short interest in the stock has climbed from around 2.5% a year ago to a peak of 12.2% in October 2022. More recently, shorts have slightly eased to 9.8% as of 23 January 2023.

Surprisingly, three of the four quarterly updates from 2022 triggered rather sharp selloffs:

• 19 January: -16.2%

• 21 April: -21.2%

• 20 July: +23.0%

• 19 October: -22.1%

With such a high short interest, will they eventually cover and trigger a sharp rally? Or will short interest remain high due to the above reasons?

Another quarterly bites the dust

Megaport continued to post its usual mid single digit quarter-on-quarter (QoQ) growth across most of its key performance metrics, including:

• Monthly recurring revenue of $12.4m, up 6% QoQ

• Revenue of $37.0m, up 10% QoQ

• Customers were 2,739, up 1% QoQ

• Average revenue per Port of $1,260, up 3.8% QoQ

Of note, the company delivered an EBITDA profit for the December quarter, building on the "move to profitability at the end of last fiscal year".

Still, Megaport's cash position fell from $69.4m in the September quarter to $44.9m, reflecting increases across product manufacturing and operating costs, the timing of annual performance based incentives and higher capital expenditure.

Volatile demand

Management noted "lengthening sales cycles" amid today's uncertain economic backdrop. This comment may have been another factor dragging the stock lower on Tuesday.

Interest in Megaport products remains high, as evidenced with continued strong sales pipelines, however current economic uncertainty seems to be delaying customer decision making, lengthening sales cycles. It is anticipated that sales trends will improve when the global economic outlook stabilises.

Broker views

There are three broker notes for Megaport so far this year.

• Citi: Buy rated with a $10.95 target price

• Morgans: Upgraded to Add from Hold with a $9.00 target price

• Credit Suisse: Neutral rated with a $7.10 target price

The average target price among the brokers is $9.02 or a 25% upside from today's open of $7.20.