Short Sellers Survive a Tough Tape, Believing Their Day Will Come

Carson Block, chief executive officer of Muddy Waters, pioneered activist short selling. (Betty Laura Zapata/Bloomberg)

Key Points

• Short-biased hedge funds, including activist short sellers, continue to operate and find opportunities despite a challenging bull market.
• Prominent activist short sellers like Carson Block, Soren Aandahl, and Dan David are actively publishing research and making bearish calls.
• Activist short selling involves extensive research, shorting stocks, and buying short-dated puts to profit from price drops, often unwinding positions quickly.

SAN FRANCISCO—A hundred short sellers waited patiently this week for a fat pitch at Oracle Park here. In a bull market, they are few and far between.

The Bay Area hedge fund Kingsford invites members of the short selling tribe each year to face a pitching machine, drink beer, and rant about investments that have yet to work.

Short sale bets on a stock’s drop may be common on Wall Street, but those who stood around the third base dugout on Tuesday do it more than most. Their firms are known as “short-biased,” and they spend their days looking for public companies they think are overvalued.

Veterans have retired from the game, like Jim Chanos who made a name pouncing on Enron. New players have taken their place, with new strategies—including the activist short sellers who release long, splashy critiques of a stock, hoping to generate a quick gain on the drop.

A Murderer’s Row of activists were on the field Tuesday. They included Carson Block, whose Muddy Waters Capital pioneered short activism 15 years ago; Blue Orca Capital’s Soren Aandahl; and Dan David of Wolfpack Capital Partners.

“We’ve had to be really selective this year in light of a punishing tape,” said Aandahl of this year’s rising stock market. Nevertheless, Blue Orca has maintained its usual pace of six or seven reports in the past 12 months, including successful bearish calls on Baldwin Insurance and Teladoc Health.

Even in a bull market, there will always be stocks that get ahead of themselves. “We aren’t just enduring but thriving,” Aandahl says of his business.

Carson Block became the first prominent activist short, with calls on stocks like Sino-Forest, TAL Education Group, Blackstone Mortgage Trust, and Sunrun. His firm Muddy Waters now runs two funds whose principal strategy is short activism.

It takes months to do the intense research needed to publish a hundred-page report on a stock, so an activist firm can only put out five or so ideas a year. Before publishing, it shorts the stock in question and buys short-dated puts to profit off any drop in share price. It typically unwinds that position a day or two after publication. Buy and hold it isn’t.

With its two funds, Muddy Waters can now trade more frequently by serving as a “balance sheet” investor in smaller activist firms, providing money for their activist events. If it backs five firms with five ideas each, that supplements Muddy Waters’ homegrown ideas to bring its annual trades to about 30 a year.

Short activism isn’t for the meek. Algorithmic traders try to sniff out an incipient activist campaign. Mobs of retail traders sometimes rally to lift a meme stock, despite any weaknesses highlighted by an activist. Giant passive index funds will buy any component of their benchmark, regardless of its fundamentals.

Stock market enforcement also affects short sellers. Their allegations of corporate wrongdoing won’t matter much, if federal prosecutors and the U.S. Securities and Exchange Commission don’t take action.

In recent years, complaints by some companies and law professors got the government to investigate the short activists—looking for evidence that activists lied in their reports or manipulated stocks. Block said that Muddy Waters spent millions defending itself during an SEC investigation, which was ultimately dropped.

The short activist Andrew Left currently is fighting federal civil and criminal cases, which allege that his reports were insincere because he got out of certain short positions at prices that weren’t those his reports listed as the fair value. Left says his reports are truthful and that he has done nothing wrong. He notes that money managers recommending a long position on television or in a financial publication aren’t expected to always hold out for their target price.

As the stock market arcs toward the outfield, there are endowments, family offices and wealthy individuals now giving money to activist shorts, in case the law of gravity comes back in vogue.

Wolfpack’s Dan David raised money earlier this year. “It’s a plausible time to continue doing what I have done for 15 years during an unprecedented bull market,” he says.

“Having said that,” he concedes, “if I were just starting out in this business, I might choose something else.”

Write to Bill Alpert at william.alpert@barrons.com