Russell reveries

I said at the outset I'd be taking a lot of cues from the message boards for my topic of choice. On this occasion, I want to address a recent example of the inexplicable themes that pop up there from time to time.

Re: Today even institutions bought by: watchitgo2 Long-Term Sentiment: Strong Buy

03/16/05 10:11 pm Msg: 194707 of 194736

Dukey, Did you understand Blue is BUY and Red is sell? And the pie graph shows 21% institutional BUYS. Or about 11,000 shares. That was today. Did you also note the 1 month almost exclusive...BLUE BUY signals? This Qtr. nearing the end, BIG MONEY has been lurking. The sudden spike up and activity has brought more and more interest. The Russell index will include REFR again, so the volume will increase toward end of this month. Shorty is over-extended as price rises. As of year end 2004 Note: Botti Brown and Morgan Stanley. http://www.nasdaq.com/asp/Holdings.asp?symbol=REFR%60&selected=REFR%60 Also note an eerie coincidence an almost exact mirror of the same time 2 years ago....The sudden drop and rapid recovery..a slight pullback, then another sharp climb. This climb may stick and settle??? http://finance.yahoo.com/q/bc?s=REFR&t=5y Buh BUY

"The Russell index will include REFR again"!!??

Let me explain my incredulity.

The Russell index, or, more precisely, the Russell 3000 Index, is designed to consist of the 3000 largest publicly trading American companies. (Foreign companies trading on the American exchanges are explicity excluded.) This index, as well as its subindexes, the 1000 and 2000 (referring to the the top 1000 and bottom 2000 of the total 3000), are very popular indexes that are tracked by fairly substantial numbers of index funds.

When REFR fell below the threshold of the Russell 3000 last year, the resulting selloff of an aggregate of over half a million shares steadily crushed its price from $10 to the $6 range it remains in today. So, needless to say, the shareholders dream of REFR's restoration to the Russell, so that all those funds will have to buy all those shares back, at what they expect will be much higher prices than where they sold.

There are, of course, a few problems with this scenario.

The first problem is the premise that all they have to do is get back onto the index, and half a million shares of instant demand will show up. Not exactly true. Most index funds do not have the capital to own positions in all 2000 companies of the "small-cap" Russell 2000, much less the full Russell 3000. Instead they purchase what they term a "representative sample" of the index. How this sample is determined varies from fund to fund and is no doubt kept quite secret, but one common method appears to be longevity on the index. REFR was on the Russell for four years, and each year they made the cut, they were rewarded with a small surge in buying around the reconstitution date. If that holds true, then REFR, even if they were to make the index, would be back to "year one" with the funds, which would mean only a relatively small amount of index buying, maybe 100,000 shares or so.

Of course, the bigger problem is the matter of REFR's prospects for getting back onto the Russell in the first place. The cutoff for last year's Russell index was around $175 million in market capitalization. REFR's current market cap, counting the shares issued in the most recent filing, is a little over $80 million. So right off the bat, REFR needs to pull at least a double, between now and May 31st, to even be in the running for inclusion on the Russell.

Okay, so maybe it's a longshot, but if they get just the right bit of news and catch some institutional interest, maybe they have a shot, right? Well... there's still a problem. About a million problems, actually.

Last month, REFR closed a financing deal, placing 1,000,000 shares with four anonymous hedge funds at a price of $5.00 each. The funds also received 200,000 warrants, or options, to purchase more shares at $7.50 each.

Now, the perception one gets from the message boards is that your average individual REFR investor is rabidly loyal to the company and wouldn't consider selling a share for anything less than a truly obscene profit. Whether or not that's true, that most certainly does not apply to managers of hedge funds. You don't get wealthy people to trust you with their millions, by having a tendency to get "religion" on a single security. You're expected to invest in what works. Saying that a story could take ten years, or even one year, to play out, doesn't hold water with hedge fund investors. They're paying you to make money for them now. And if you don't, they'll find someone else to do it.

So the idea that, in the event that the price does somehow shoot up to $8, $9, $10, the hedge funds will just sit tight and not take the gorgeous profits being handed to them at those levels, is a highly absurd one.

And even if, somehow, the stock rises so quickly that even the hedge fund profit taking can't blunt its rise, guess who will be there and much more than happy to sell the index funds all the shares they care to purchase? Our hedge fund friends, of course.

So there's just one of a long series of fantasies held by the message board promoters of REFR. There will be much more to come, but for now, we've got more official fantasies coming up, in the form of the annual conference call. See you back for that!