Short sellers see golf company's outlook improve. (Up Front).

There's a war brewing between holders of National Golf Properties Inc. stock and short-sellers who have targeted the ailing golf course landlord as a potential bankruptcy candidate.

Since late last year, short interest in National Golf stock has risen to about 1.8 million shares, or 13.5 percent of all shares outstanding, from minimal levels before late summer, when the company began to show signs of distress.

Most of the short selling took place between February and April, when National Golf's stock hovered between $5 and $10.

While the shorts were selling, other investors were coming to a different conclusion: that the company's assets were undervalued. These new buyers, hard-nosed professionals who have taken an activist stance toward National Golf's management, have replaced the traditional shareholder base that favored the steady returns of a Real Estate Investment Trust.

These buyers purchased at around the same times and at the same prices as the shorts were selling. Recently, National Golf's stock has traded about midway through the range, at $8.24.

Sooner or later, one of these groups is going to get creamed. But who?

The momentum lately has been on the side of the buyers, or the "longs." National Golf's stock has crept up recently amid signs of an improving relationship between National Golf's interim chief executive, outside director Charles "Skip" Paul, and the institutional investors that have opposed his proposal to merge National Golf with its heavily indebted operating affiliate, American Golf Corp. Paul has been visiting some of National Golf's major shareholders, and has had some success in convincing them that he's trying to preserve shareholder value.

Market dynamic

While to varying degrees these large shareholders still oppose the merger plan, they're willing to acknowledge other steps Paul's taken to increase the value of the combined companies, including raising cash through golf course sales and ousting several top American Golf executives.

Said one shareholder: "We've said our piece, now it's time to see what (Paul) does."

Also at play is a market dynamic that could work against the sellers. While short sales initially help push a stock's price down, they also represent a commitment to buy replacement shares sometime in the future. (Short sellers hope to profit from declines in a stock's price by selling borrowed stock and buying it back later at lower prices.)

In the case of National Golf, with 13.1 million shares outstanding, the 1.8 million in short interest represents a significant guarantee of future buying volume.

Any positive event--say the announcement of a deal to sell National Golf at a price that's higher than it is trading for now--could send short sellers scrambling to "cover" their positions by buying stock. When this pressure gets overheated, it is called a "short squeeze," and it can propel a stock to unusually high levels very quickly.

In National Golf's case, nearly half of the company's shares are in the hands of long-term shareholders who aren't likely to sell on a short-term price swing. Chairman David Price, other insiders and most of the institutional shareholders all are said to believe the stock is worth somewhere in the teens, based on its asset value. Price isn't likely to sell unless forced to; in fact, any transaction will probably be structured to minimize his tax burden.

The implication is that if and when a deal is announced, short sellers will find few shares available for purchase when they try to cover.

"I don't know where they're going to find the shares to cover," said one institutional owner who said he's gone down National Golf's shareholder roster.

To appreciate the sensitivity of these events, take a look at the trading that occurred on May 30, the day rumors swept the market that a deal was imminent that would take National Golf private.

The stock jumped 72 cents, or 9.1 percent, on trading volume of 385,000 shares. Trading volume in the weeks before the rumors was generally well below 100,000 shares daily.

Extensions on debt

Supporters say National Golf has received interest from high-quality investors on its plan to merge with American and simultaneously seek an infusion of outside equity into the combined company. Though it's unclear what form a final deal might take, sources said the company is working its way toward an announcement soon.

(National Golf officials declined to comment.)

Meanwhile, the banks are cooperating by giving National Golf numerous extensions on its debt agreements. While business is still down, the company is benefiting from better weather, said people whose sympathies are squarely on the side of the "longs."

On the other hand, National Golf still hasn't published enough information about course-level results, cash flow from third-party courses operated by American Golf, or terms of any proposed transaction to arrive at a conclusion about the company's worth, said Steve Sakwa, first vice president at Merrill Lynch.

"I'm not sure why this is taking so long, this mess has been going on since November' said Sakwa, who rates National Golf shares a "sell." Based on the incomplete information Sakwa has, National Golf's asset value is less than $4 a share.

In similar situations, things have ended badly, Sakwa said. "Until we get definition of who's paying what, who owns what and what the lease structure is, we don't want to be invested in the stock."

Sakwa acknowledged conditions exist that could allow a short squeeze to develop, but he's not convinced that it will. "Based on information that we have, we're concerned that there could be a downside," he said. "But we realize that we're not playing with a full deck of cards here."

[GRAPH OMITTED]

National Golf Properties Inc.

Stock Prices

June 12, 2001  $26.40
June 12, 2002   $8.35

Note: Table made from line graph
YEAR (Dec. 31)                 2001    2000

Revenue (millions)           $118.4  $118.5
Total Expenses (millions)        73    45.8
Operating Income (millions)    45.3    72.7
Net Income (millions)        (.363)    19.4
Earnings Per Share           $(.03)   $1.52

RELATED ARTICLE: SUMMARY

Business: Real estate investment trust

Headquarters: Santa Monica

CEO: Charles Paul (interim)

Market Cap: $109.6 million

Dividend Yield: 22%

Total Liabilities: $633.3 million

P/E Ratio: 246

Long-Term Debt: $448.8 million

'Death in the Family'

GOLDA "Judy" Stout trusted her stockbroker, Frank G Gruttadauria. The broker was there for her sister, Ann, in the last year of her life. She said he visited the sisters in Ann's Palm Desert home and "was like a son to me--he handled everything."

Now Gruttadauria is in jail, facing lawsuits, industry sanctions and criminal charges related to accusations that he appropriated $40 million from more than 50 clients, including 87-year-old Stout, and covered his actions with false financial statements to the investors. The broker was formerly employed by SG Cowen Securities Corp. and Lehman Brothers Holdings Inc.

As a long-term investor, Stout picked her own stocks, monitored them daily, held them for years and reinvested dividends. She turned an initial $100,000 stake in dozens of stocks into millions.

In testimony at a Congressional hearing on the Gruttadauria case last month, Stout said she invested $850,000 with the broker over a decade. The account she thought had grown to $2.5 million in November was worth only $86,000 as of her December statement.

Gruttadauria, who entered a plea of not guilty in February, is being held in a Lake County, Ohio, jail charged with bank fraud. The case illustrates the difficulty that Stout and other investors face if they try to learn the background of the people handling their investments.

Under the current system of industry broker record disclosure, it's unlikely Stout could have obtained a complete background check on Gruttadauria.

The National Association of Securities Dealers Inc. regulates, tests, registers and represents brokers and brokerages, and also offers a public disclosure program on their members' backgrounds. A search of that system showed only the recent government and court actions against Gruttadauria.

Yet when I requested the brokers record through the Illinois Securities Department, a much different story emerged. The 61-page Illinois report notes 36 current customer complaints in detail. Similarly, the Ohio Division of Securities report on Gruttadauria notes the same customer complaints.

The industry disclosure system sent me a message stating that the file on Lehman was too large to e-mail and that it would mail the results in at least 15 business days.

The SG Cowen records, which were e-mailed within minutes through the industry system, showed six regulatory actions involving $1.3 million in fines from 1994 to 2001 and no customer complaints were listed.

Neither the industry nor state agency records explained or rated how serious the actions against Cowen were or how the firm compared to its peers. That's how records are reported in the industry's system--there's no context. Total complaints against brokers are not even reported by the industry, so there's no way of comparing firms.

The most telling investor complaint indicator is that broker-customer arbitration cases alone rose 41 percent in 2001 from the previous year.

Lehman's Ahearn said the brokerage has returned $20 million to Gruttadauria's clients to date and that "the vast majority of these clients' funds were gone before Cowen was acquired by Lehman." Lehman believes its compliance system acted as a deterrent. The brokerage house said Stout has refused an offer to repay her the $25,000 Lehman claims was missing from her account.

Stout said she's suing Lehman Brothers and Cowen. As for the broken trust, she said, "It's like a death in the family."

John F. Wasik, Bloomberg News