Digital Brands Inc. (NASDAQ: DBGI) is possibly one of the most undervalued NASDAQ plays beaten and battered by a reverse stock split and an avalanche of Naked Short selling. This stock is compelling because it’s a low floater with only 540K shares outstanding. The stock has been trading at multiples of its float until the past five days when it stabilized for about four days with approximately 350,000 in volume. The naked short playbook requires volume to cover and shares, for that matter, but the shorts ran out of time today. The shorts hoped for an S-1 to become effective, enabling them to cover by purchasing approximately $7.5 million worth of shares by subscribing to the offering. Instead, they were placed on the Threshold Security list along with short squeeze favorite Cosmos Holding Inc. (NASDAQ: COSM). The Threshold Security list informs brokers to clear their books in 13 days.
Shorts Out of Time
The company was required to finalize the Sundry acquisition by November 30, 2022, four trading days away. If there is no effective registration by that date, the company could lose the acquisition, but worse, the shorts would lose their ability to exit by covering with the shares in the offering. Using a price of $5.00/share, the shorts were hoping that the company would dilute with 1.5 million shares. To keep the math clean, right after the reverse, 2.3 million shares traded, which was many times the float. The stock barely rose after the reverse split, and the shorts piled on, breaking the momentum of the longs hoping to drive the price lower, knowing that an offering was in the works. They certainly succeeded in driving the stock price from $8.40 on the day of the split to a low of $3.21.
The shorts had the perfect plan, but they cannot control the SEC, who seems to be taking their sweet time making comments on DBGI’s S-1. The shorts might have cooked their goose by triggering a trading watch on the stock due to volume that was so many multiples of the float it was so obvious to regulators that the stock was under attack. Perhaps this is the one time that the SEC might be trying to protect retail stockholders by slow rolling the approval, thereby enabling the short squeeze. Additionally, DBGI made the Threshold Securities list, which means the cumulative fail-to-deliver’s are at an unacceptable level. Now the brokers have 13 days from Monday to cure the issue with market buy-ins. Longs now have short covering to look forward to by the deadline, but the reality is that brokers can cover at any time, and a rapid runup could trigger a massive short-covering squeeze because so many shares were shorted. The movement at the end of trading today was indicative that brokerages are getting a head start on covering.
The Threat of Going Private – The Nuclear Option
On the latest earnings call, the CEO of DBGI, Hil Davis, indicated that if the stock price didn’t cooperate, the company would very much consider an offer to go private. He indicated that private company multiples were alive and well and fetching a multiple of 1.5X sales on the low end. The company is a subfraction of the real value he places on the company. He mentioned that his suitors were asking him, “why stay public if you can’t raise money or do acquisitions?” He basically said that the company is worth $45 million right now, or $83.33/share. If the stock continues to stay at depressed levels, he said that he would entertain offers to go private to continue his acquisition of new brands.
The best example of a go-private strategy is Meta Materials (NASDAQ: MMAT), the parent of Meta Materials Inc. Class A (OTCMKTS: MMTLP), a company that just had its S-1 go effective, which enables it to pursue its delisting or privatization. The brokers must close out their client’s positions before going private in the coming weeks. This has led to a massive scramble in share price. DBGI has solidified its retail brands and business model, which means the only reason it would need money is to grow faster. It’s very conceivable that the shorts keep messing with DBGI and that the CEO will pull what we all have seen as the Nuclear Option of privatization. DBGI could be the next MMTLP, and the conference call that many may have missed was the warning shot across the bow to the shorts. If the shorts mess up this acquisition and don’t cover soon, it could be lights out for the shorts.
When stocks become short-squeeze plays, the investors abandon looking at the fundamental story. The market cap of DBGI is $2.3 million, yet the company is expected to generate close to $30 million in revenues next year. Digital Brands is, at heart, an apparel company with a serious retail twist. They figured out that the fashion-conscious like to mix and match brands. That simple tenant underpins their business model because they build customer loyalty instead of brand loyalty, which is a losing game. When positioned as a stylist armed with metadata on the customer’s wardrobe, they can easily market the customer new ideas tailored to their tastes and preferences. They are driving customer acquisition costs down to the teens while the average brand spends $75. Keeping their overhead constant has been a big win for them as sales ramp.
There is much more because their model is now sustainable. They just got a purchase order financing line in place, which allows them to ramp sales without having to raise equity to finance the growth. Their growth was partially responsible for the need for capital so investors thinking that dilution of old will remain are sorely mistaken. The need for capital is to pursue accretive acquisitions. Even at these low levels, the Sundry acquisition is accretive on day one because its net revenue is anticipated to be multiples of the existing market cap. The shorts haven’t done their homework, and neither have the longs otherwise, they would be buying the stock in droves. The stock price is a complete dislocation from reality. If the Sundry acquisition comes into the fold, the company will generate over $50 million in revenues. At a conservative 1.5X sales, the market cap of the consolidated company would be $75 million. Fully diluted is 540K existing, 667K noteholder, and 1.5 million offering is roughly 2.7 million shares after the S-1. To make the math easy, round up to 3.0 million shares in the company. This makes the Sundry acquisition worth $25/sh, with the shorts playing spoilers.
Blowout Earnings Report Falls on Deaf Ears
A week ago, the company reported $3.4 million in revenues with $.4 million in deferred revenues based on an acceptance date. The bottom line is they did $3.8 million in adjusted revenues. This meant sales were up 72.7% on adjusted revenue. Their SG&A or overhead decreased to $3.6 million, and they were guiding stable costs going forward. Their gross margin was 48.3% but was also impacted by the goods’ acceptance date. Gross margins were expected to improve in the next quarter and resume their upward trajectory. Their business turned the corner toward profitability, but all the short antics deafened people. In the next quarter, profitability is expected without the acquisition, but with the Sundry acquisition, it is almost guaranteed. Investors are missing how much more efficient they are with a purchase order facility in place.
DBGI has all of the elements and setups of a super squeeze. In a worst-case scenario, the fundamental value of the stock is somewhere between $25 to $83, which means $4.50 is a bargain. It’s obvious that the shorts have ruthlessly attacked the company with the idea that they could cover with the offering, but the only problem is that they shorted 3.76 million shares since the reverse stock split. At best, there will only be 1.5 million of supply if the HC Wainwright deal is allowed to proceed. This represents seven times the float. The SEC’s REG SHO requires brokers to do buyin’s which means the clock is ticking, and if the stock starts to squeeze, there will be a massive run for the exits with all the fanfare of successive trading halts. There is an inflection point in about four trading days, and it’s either higher or parabolically higher. If they somehow close the financing deal, the scarcity of shares in the offering will lead to a squeeze of 2.26 million shares. If S-1 doesn’t become effective in time, it makes no sense for the company to pursue the acquisition, which means no shares will be coming on the market until they can identify another target. This news will create the parabolic squeeze because, with only 540K shares of supply, this low floater could go into low earth orbit. As always due your DD and figure out your exit points beforehand because when the squeeze happens, you won’t have time to think.
Good luck to all (except the shorts and Cramer)!
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