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The Next Netflix-esque Short Squeeze?

Alexander is a member of The Motley Fool Blog Network -- entries represent the personal opinion of the blogger and are not formally edited.

Shares of Netflix (NASDAQ: NFLX) were up nearly 25% on April 23 after the growing company reported better than expected earnings. This is not the first time Netflix shares have surged after positive results. Shares gained over 42% on Jan. 24 after the company reported a surprise profit. What did these two gains have in common other than a basis in tangible news? Short sellers of the stock got burned and were forced to buy shares in large numbers.

This event where short sellers are forced to cover their short positions by becoming buyers is known as a short squeeze, and it often has the result of driving shares well beyond typical levels. Short squeezes usually happen to companies with a high percentage of shares sold short or an extremely tightly held supply of shares where demand for shares to cover exceeds the supply of shares available at a reasonable price. Here we will take a look as to whether shares of Tesla Motors (NASDAQ: TSLA) could be in for a similar short squeeze.

Short squeeze?

A company with such a radical business plan as Tesla is bound to attract more than its fair share of bears who consequently short the stock. For March 28 (the latest data available on NASDAQ.com), the short interest for Tesla stood at just over 31 million shares or about 43% of the float. With so many shares sold short, many investors could be expecting a short squeeze.

This could have multiple effects. If those who are bullish already expect a short squeeze, they may increase their positions, thus adding more buying pressure to the stock. Those short the stock may also see a short squeeze coming and begin to cover their position as the stock rises. However, like the bullish buying, covering shorts adds buying pressure to the stock and drive up the share price.

Tesla is one of only a few automakers that is in a likely short squeeze position. Companies like GM and Toyota are usually too big with too few shorted shares for a short squeeze to grab hold. However, Volkswagen Group AG (NASDAQOTH: VLKAY) proved a notable exception to this rule when short covering, caused by Porsche revealing it had nearly cornered the market in Volkswagen shares, briefly made Volkswagen the most valuable company in the world. Shares of Volkswagen were briefly driven to more than 1,000 euros each as hedge fund managers short the stock moved to cover in a market where demand was high and supply was almost non-existent.

Since the squeeze, Volkswagen shares have fallen back in line with more typical valuations for automakers. Unlike the Netflix squeezes, the Volkswagen squeeze was driven by a tightening of the share supply, not by any major company news. After the market adjusted for Volkswagen’s true value (and after Volkswagen turned the tables and took over Porsche), Volkswagen shares traded largely in line with those of other major automakers. Due to the unlikeliness of another automaker trying to take over the now larger Volkswagen Group, another Volkswagen short squeeze does not seem to be in the cards at this time.

However, Tesla’s size makes a buyout offer for the automaker more likely than one for Volkswagen. But unlike the Volkswagen situation where Porsche was able to secretly acquire the vast majority of the company, a buyer of Tesla would have to make its growing holdings public. Under this situation, the short squeeze would probably not be as large as the Volkswagen one but could still result from shorts rushing to cover below the takeover price.

A short squeeze in Tesla, if it does happen all at once, would most likely be driven by some piece of positive news that excites the markets as the profitability announcement did. At this point, Tesla shorts are deeper in the red and may begin to cover earlier hoping to do so before the stock gains another 20%.

Tsunami of hurt

Back in September 2012, Tesla’s CEO Elon Musk warned those short Tesla shares that a “tsunami of hurt” would be coming their way. While this sounds like big corporate talk, the share price increase since September has left shorts since then deep in the red.

In September, Model S production was still tooling up. Today, Model S production is running at full capacity with profits now expected for Q1 2013. Shares topped $50 each on April 22 slicing through the $50 level far easier than it took to move past $40 level. If Tesla continues to execute, a short position in Tesla will continue to get more painful.

If progress just continues to happen over time, shorts could slowly cover adding a long period of buying pressure to the stock. However, if a strongly positive piece of news or buyout offer were to be released for Tesla, shorters of this electric automaker could find themselves in the same position as Netflix and Volkswagen shorts.

Alexander MacLennan owns shares of Tesla Motors. The Motley Fool recommends Netflix and Tesla Motors. The Motley Fool owns shares of Netflix and Tesla Motors. Try any of our Foolish newsletter services free for 30 days. We Fools may not all hold the same opinions, but we all believe that considering a diverse range of insights makes us better investors. The Motley Fool has a disclosure policy. Is this post wrong? Click here. Think you can do better? Join us and write your own!

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