Looking back over 2019, it seems that activist short sellers had their knives out more frequently with a number of fairly audacious reports turning heads in the City.
The uptick in activity appears to have been borne out in an annual review by data firm Activist Insight, which showed that following a small dip in 2018, campaigns by activist short sellers jumped to 168 last year from 159 as markets and share prices soared.
Shorting a stock is when an investor borrows shares in a company and then immediately sells them for a profit, hoping that the stock price goes down so they can buy the shares back at a lower price and return them to the lender, pocketing the difference.
Activist short sellers take this process one step further by not only shorting shares but also publishing their reasons for doing so in an attempt to force a decline in the stock price.
Short selling campaigns made the headlines on several occasions last year, particularly those orchestrated by hedge fund Muddy Waters, founded by New Jerseyite Carson Block.
The fund has been behind two of the biggest short seller attacks of 2019, one in August against litigation financier Burford Capital Limited (LON:BUR) and another in December against Emirates-focused hospital operator NMC Health PLC (LON:NMC).
The results have been devastating for the share prices, with Burford’s stock having lost around 57% of its value following Muddy Waters’ broadside while NMC has plunged 68%.
Muddy Waters tops list of activist shorters in 2019
Aside from its penchant for causing media storms, Muddy Waters was also the most active short seller last year by Activist Insight’s metrics, launching five short campaigns in the year with an average target company market cap of US$7.1bn.
In second place was Hindenburg Investment Research, which launched six campaigns but with an average target market cap of US$2.1bn. The firm has also turned its guns on Norwegian software firm Opera Ltd (NASDAQ:OPRA) and Canadian augmented reality specialist NexTech AR Solutions, the latter of which halted trading of its stock last Friday following a report published by the short seller.
Following behind the top two was New York fund Spruce Point Capital, anonymous short seller Emerson Analytics and Blue Orca Capital, whose founder Soren Aandahl caused shares in Chinese furniture maker Kasen International to plunge 91% in a single day in November after lambasting the company’s “illusory” investments in Cambodia.
Outside of the top five, another famous name in the activist shorter space is Gotham City Research, which joined Muddy Waters last year in its campaign against Burford.
Iuri Struta, a senior financial journalist at Activist Insight, said that the quality of activist short seller reports into the companies they target “has generally been good”, which he attributes to their need to preserve a reputation for competence and encourage investors to back their strategy.
“Most [activist short sellers] will not publish unless they have a high degree of confidence their thesis is correct”, Struta said.
There is an ongoing debate around whether short selling, particularly the activist kind, is ethical. However, a 2018 report by Duncan Lamont, head of research and analytics at Schroders, said it was “the more extreme activist shorters” that gave the practice a bad name, with some having been found guilty of spreading unfounded rumours around the market in their pursuit of profit.
By contrast, Lamont said the work of many activist shareholders can highlight “previously underappreciated issues” in a company such as accounting irregularities which can either force management to act or allow shareholders to get out before the firm collapses.
But the shorters don’t always get it right
While many of the prominent short sellers appeared to have succeeded in their efforts to get a company’s share price to tumble, shorting remains inherently risky and can hit investors hard in the wallet if they make the wrong call.
A prime example is electric car maker Tesla Inc (NASDAQ:TSLA), one of the most shorted stocks on the market, which in early February caused the worst single day loss for short sellers after a 20% surge in the share price cost them US$3.2bn in lost bets.
The company’s continued defiance of the naysayers has cost shorters around US$9bn already in 2020. One of the funds losing out is Greenlight Capital, whose founder David Einhorn has repeatedly sparred on social media with Tesla’s controversial chief executive Elon Musk.
Regulators could add pressure
Looking ahead, the activist short sellers could be in for a bumpy ride in 2020 as regulators begin to tighten their rules over the practice.
The ‘war on shorting’ began in February last year when the German Federal Financial Supervisory Authority (BaFin), banned short selling of shares in payment firm Wirecard after the stock price plunged following a series of Financial Times reports alleging fraud at the company. The regulator said the short selling presented a “serious threat to market confidence” and opened an investigation into possible manipulation.
More recently in October, Turkey banned short selling in the shares of seven banks, while French politicians proposed introducing new disclosure requirements around bets against derivatives, criminal charges for “abnormal functioning of the market” and tracking to whom shorters sell their borrowed shares.
However, many short sellers have said the proposals will be ineffective, with Gabriel Grego, founder of Quintessential Capital Management, saying the French suggestions will only be “postponing the inevitable blow up of frauds and encouraging criminal corporate behaviour”.
Similarly, Muddy Waters said in a response to the French report that transparency around securities lending was not “sufficient to fight against the risks of manipulation of stock prices”.
But some are optimistic about 2020
However, despite these potential hurdles short sellers appear to be optimistic about the year ahead.
This confidence seems to be being borne out already, with 2020’s first prominent short attack deployed earlier this month by the mysteriously named ShadowFall hedge fund against magazine publishing group Future PLC (LON:FUTR).
Ben Axler, chief investment officer at Spruce Point, said that the environment for activist shorters remained “robust and attractive”, with the possibility of interest rate cuts likely to lead to “extreme earnings disappointment” at large cap companies, driving share prices down as a result.