Investor Relations: Types of Short Attacks and Short Sellers

"Always be aware of the Sell-Side Charles Bronson; a sell rating with a death wish!"

When facing a short attack, investor relations officers must take the time to understand what type of short attack does the company face. Not all short attacks are created equal, and not all short sellers represent the same level of concern. The type of short attack your company may be susceptible to will be a function of how clear and confident, as well as how open and transparent the investor relations program may be. The more active and engaged you are, the less likely you will face the wrath of one of the more onerous short sellers described below.

By running a clear and confident, open and transparent, investor relations program that maintains dialogue with both positive and negative constituents, you can avoid the headache altogether!

Identifying Short Attack Duration

Long-Term Vs. Short-Term: The first characteristic the investor relations officer must identify is the likely duration of the short attack. Understanding the duration risk of the short attack allows you to better understand the amount of work needed to refute and eliminate the short attack.

Short-term short attacks revolve primarily around valuation, as these are the riskiest to analyst reputation. Major accounting scandals represent the longest-term short attacks. An accounting scandal can take significant time to unearth and expose, as the short attacker needs to piece together the company’s accounting from the outside. These attacks require significant work and deep channel checks.

Two additional types of short attacks revolve around structural flaws either with the company or the industry in which the company operates. These types of short attacks will vary in duration according to the company’s ability to address the concerns identified by the short attack. Structural flaw short attacks can easily be combated by an enterprising IRO that can adjust the company narrative accordingly. Execution revolves around doing the research to address the short thesis, and then communicating that narrative via the investor deck and sell-side community.

When I ran IR at DFT, we faced a structural industry flaw in the summer/fall of 2016 that argued hyperscale data center demand was abating for the time being. The thesis stemmed from comments made on Microsoft’s C2Q16 earnings call. When digging into the conference call, it became clear to me that MSFT was not signaling an abating demand environment. Furthermore, our own sales pipeline suggested that demand remained robust.

Types of Short Attacks

Valuation: A sell call due to valuation represents the simplest form of short attack and the most easily rectified. The analyst simply thinks the stock price ran too far too fast, that the stock is likely poised for a price correction. On the sell-side, analysts can be subject to ratings quotas whereby the analyst mush have a certain number of buy, sell, hold ratings based on the size of coverage list. While at DFT, we encountered this with REIT boutique Green Street Advisors. Their ratings system required the analyst to have one buy, one hold, and one sell, as he covered three data center REIT stocks. The analyst ratings would change as valuation evolved over time.

Accounting Scandal: These are the worst ranging in pain and duration by how deep the accounting problem permeates the company. An accounting fraud like Enron or Worldcom represent the strongest examples of extreme pain. Sometimes the accounting scandal turns out to be a simple accounting error that can be rectified without much harm. Other times, the accounting errors result in complete financial restatements.

Nevertheless, accounting short attacks are the worst because there truly is no defense other than cleaning up your accounting. While many times these issues can be resolved in a quarter or two, sometimes the accounting issue extends longer-term. The biggest struggle will revolve around repairing management’s damaged credibility with investors.

Structural Flaw at the Company: A structural flaw at a company represents something that prevents the company from reaching its optimal performance. For example, the company’s sales and marketing expenses, research and development, or gross margins are abnormally low relative to its competitors. A company specific cultural flaw represents something negative that cannot be easily changed for the better.

Structural Flaw in the Industry: A structural flaw in an industry can be something as simple as demand being less robust than thought to something more complex the industry is going away e.g., print advertising in 2008. Again, an industry structural flaw represents something that negatively affects operating performance and keeps the industry from optimal performance and cannot be easily changed for the positive.

Types of Short Sellers

Sell-Side Analyst Valuation: As stated above these types of sell calls are quota driven. There is no reason to take the valuation call personally or turn it into a pitched battle. While these types of calls are often poorly timed in management’s eyes, these calls should cause the least amount of stress for the company and/or IR.

The best course of action is to continue to converse with the analyst rather than taking the typical course of cutting them off. Valuation calls are easily changed and represent the riskiest call to the analyst. No sell-side analyst wants to drop a sell on valuation and see the stock rip higher by some ungodly percentage. Given the quota driven nature, these calls typically lack real depth of research and hinge completely on relative valuation analysis.

Sell-Side Analyst Charles Bronson: The sell-side analyst that thinks he or she is Charles Bronson essentially has a death wish, because their sell call will likely end their research career. I epitomize the Sell-Side Charles Bronson given my extremely successful sell calls on ehealthinsurance (EHTH), Cerner (CERN), my bearish Hold on Teladoc (TDOC), as well as my bearish musing on any traditional electronic health records vendor (looking your way Allscripts (MDRX) and CPSi (CPSI)) not named athenahealth (ATHN). A more famous example of the Sell-Side Charles Bronson is Mike Mayo in the Large Cap Banks vertical, who was exiled from Wall Street despite regularly appearing on CNBC.

The sell-side Charles Bronson is dangerous because, he or she has done the breadth and depth of work required to establish a provocative short call. He or she is constantly refining and researching to make sure that the bear thesis remains intact. Such efforts are thoroughly exhausting!

In this case, the IRO will be best served through consistent and open communication with the negative analyst. Company IR should continue to focus on telling their narrative adjusted for any legitimate concerns raised by the short attack. The worst solution is resorting to personal attacks, flame mail, and the ever-popular freeze out. Any sell-side analyst that has rated a company a sell will have stories about the vitriolic emails received from either IR or management ripping them a new rear end.

In this case, the analyst has likely done more work than you realize and will just further entrench his or her negativity the more you treat them like crap. Remember, Wall Street talks to both the negatively biased analyst and the company. There is always a chance that Wall Street will decide the analyst is right even if the company believes s/he is wrong. By treating analysts fairly, and maintaining decorum, you can neutralize their commentary if the company is executing with even modest success. After a while, investors sour of the broken watch sell-call, and start to sour on the analysts work because he or she starts to sound like a crack-pot.

Hedge Fund: This type of short seller is often either hedging a position, for example a pair trade, or making a call on a data point or event. For example, a hedge fund may have done some channel checks and realize that you will not make your quarter. Therefore, the hedge fund will take a short position simply around your earnings call, sometimes this can evolve into a longer-term call, but not that often.

If you are the short in a pair trade you can reverse this by playing some good investor relations offense. For example, when I started at DFT, the industry narrative held that wholesale data centers were unattractive and any data centers in colocation were great. Over time, we were able to educate investors to the merits of wholesale, and with a strong narrative and solid execution, we were able to become an industry darling.

Citron Research, Off Wall Street, et al.: These types of short sellers are highly vocal and range in quality of research. In my view, Citron Research represents the most famous of this group as they do real work on their calls, but have a mixed track record. Citron’s work on China, Valeant, and Mallinckrodt, represents their best work, while their work on NVidia represents their worst. Other examples of the vocal short seller include the Suhail Capital shorts directed at Veeva Systems (VEEV) and Medidata Solutions (MDSO).

Muddy Waters: We group Muddy Waters as their own category due to their extremely successful track record shorting Chinese companies. Short calls from Muddy Waters are often some of the most thorough and well-reasoned short attacks. Their work is often supported / corroborated by the PCAOB. Our assumption is based on our chance meeting with Carson Block as he was leaving the PCAOB office building on K St. in Washington, DC, several years ago.

Flashy Professional Investor Shorts: Another group of short sellers are what can be considered flashy professional investor short sellers. Two prime examples of this type of short are David Einhorn on athenahealth and Bill Akman on Herbalife. The problem with these types of shorts is that while they clearly are competent in their research, the thesis is not always fully baked.

When I launched on athenahealth in June 2014, I wrote that I thought the Einhorn short thesis was not a solid thesis given it was primarily based on valuation and calling the company a fraud. While we can debate the merits of the Einhorn short and my own take, the stock worked quite well before it finally fell last year. One of the major problems with the Einhorn ATHN short was that he was not a traditional healthcare IT investor. A short attack from an industry specialist will always carry more weight than a short attack from a generalist investor.

Let us use biotech as an example, if Baker Brothers or RA Capital were to short a biotech stock, you can take it to the bank that the company likely has problems. Conversely, if either of these funds were to short Netflix, you could very likely take the short attack with a grain of salt. If the professional investor is not typically associated with the short target’s industry, then you can likely pick at the thesis.

The Silent Short: Kynikos epitomizes this type of short seller. A more mainstream example would be Steve Eisman, who is known to the masses of society as Mark Baum from “The Big Short.” These types of short sellers are the most thorough and most dangerous. They will sneak up on you like a submarine attack, and when they do their thesis will be so well thought out that you will have significant work ahead of you in order to mount a defense. These short sellers make short selling an art.

The bottom line is that the short attack represents a function of the type of investor relations program you run. By running a clear and confident, open and transparent, investor relations program that maintains dialogue with both positive and negative constituents, you can avoid the headache altogether!