#15 – The Short Seller
Carson Block is one of the world’s top short sellers, and one of few still managing a specialist fund.
SUMMARY
In this interview, Carson explains the business of short selling; the difference between fundamental shorting and his business of shorting and exposing frauds; how he spots these fraudulent companies; where to find frauds; and why it takes Muddy Waters 3 months to launch a short campaign. We discuss the economics of a short fund, why short selling is so much more difficult than long only investing and why Europe is a more difficult area to operate.
This was a fascinating exposition of the difficulties of a business which is essential to the honest operation of markets yet whose economics have become less attractive. You will be left in no doubt as to why Carson’s firm, Muddy Waters is one of the last men standing. And in an exclusive, Carson reveals that he wants to move away from the “activist short-seller” nomenclature and tells us his proposed new business description.
GETTING INTO INVESTING
Carson’s story of transition from Chinese self storage entrepreneur to his first early short selling campaigns on Chinese frauds is well known so we only touched on this briefly. But he believes that he has a psychological bent towards shorting and that there is a major difference between his work and fundamental short selling. His work is factual rather than opinion and fundamental shorts, whether they are melting ice cubes, exposure to competition, or new product failures and similar, cannot be proved right in the present. His shorts don’t need to wait for the future to unfold which is a critical difference.
THE BUSINESS OF SHORT SELLING
The economics of a short selling shop don’t quite have the attractions of a long only firm in a bull market. You don’t get the natural growth in AUM and revenues, but it’s worse. Carson laughs that in the last couple of years, people who were prepared to dive of the high board blind were being rewarded – investors were being paid for risk. Whereas in his business it costs $0.5m to get rid of a harassing lawsuit. And his firm, Muddy Waters, only has capacity for 4-5 big campaigns a year.
SPOTTING FRAUDS
Muddy Waters doesn’t use screens to find short candidates – there are too many false positives and false negatives. Rather their process is much more qualitative. Carson pays particular attention to stocks on a tear, to highly promotional management, to CEOs promising the moon. They like companies which are indebted and resort to trickery to preserve covenants. They will read call transcripts for several years to detect broken promises, management prone to using buzzwords, executives who don’t answer questions.
ABOUT Carson Block
Carson Block is the founder of Muddy Waters Research. He grew up in New Jersey, has an undergraduate degree from the University of Southern California and a J.D. degree from Chicago-Kent College of Law. He started work for his father as a stockbroker, before going to law school, moving to Shanghai to practise law, and then setting up a self-storage business in China in 2007. His first major short selling campaign was Orient Paper and he then launched activist short selling, highlighting Sino Forest in a report. Block is best known for exposing fraudulent accounting practices in publicly traded Chinese companies and in 2011, he was ranked as a 50 Most Influential Thinker by Bloomberg Markets.
Source: Delivering Alpha
BOOK RECOMMENDATIONS
Carson recommended three books, all related to fraud or company failures. He recommends investors study these to learn more about incentives and disincentives and what these can lead to.
When Genius Failed: The Rise and Fall of Long Term Capital Management Paperback by Roger Lowenstein
This is a book by an investigative journalist. Fatal Risk: A Cautionary Tale of AIG′s Corporate Suicide Hardcover by Roddy Boyd
The third book is about corporate hubris. Crash of the Titans: Greed, Hubris, the Fall of Merrill Lynch, and the Near-Collapse of Bank of America by Greg Farrell
HOW STEVE KNOWS THE GUESTS
Steve was one of the first guests on Zer0es TV, Carson’s TV channel, and he subsequently had a call with Carson and his number 2, Freddy Brick. Steve and Freddy subsequently met up in London and after Greensill collapsed, Freddy interviewed Steve about how he had spotted the early signals. When he launched the podcast, Steve decided to make short sellers one of the themes and the podcast has so far featured Dan McCrum and Carson Block with others in the wings.