Outlook for Activist Investing & Short Selling

EMS:

Hi Carson. Thank you so much for being with me today.

Carson Block:

Thanks for having me, Elana.

EMS:

Absolutely, Carson. So, to kick off the conversation, tell us a little about the firm and how you got to where you are today.

CB:

Sure. Well, we do, as you mentioned, we do manage private funds. Before managing private funds, we were as activist short sellers, we basically published and without outside capital, we invested our own capital and/or worked with what we called a balance sheet provider, so, at that time a fund that would pay us a percentage of the P&L. But I got onto the short side, I mean, by having started out my career on the long side. I grew up in the investment industry and I was raised to believe that managements are good, and they tell the truth. And the earliest part of my full-time career, 1999 through 2002, was extremely disillusioning. I was working with my father, and we were covering micro-caps long side only. And yeah, it turns out that we were getting lied to all the time, but that wasn't just the usual micro-cap sort of phenomenon. At that time, the largest companies in the world, WorldCom, Enron, HealthSouth, Adelphia, were blowing up in fraud scandals. So, I became disillusioned, left the markets, became a lawyer, real world entrepreneur, and accidentally got back into the markets when I was living in China doing business there and found a fraud from China that was public in the U.S. and kind of, I mean, maybe as a lark or maybe just really rolling the dice, put together a report, exposing it, and literally one year later was another company that we exposed called SinoForce, and that just launched this rocket ship of a business. And that's how I got here.

EMS:

Very interesting journey, Carson. So given that, I would love to hear your high-level outlook for activist investing in short selling.

CB:

Sure. Well, activist short selling, it is a tough business for various reasons. I think a lot of people look at it from the outside and they say, oh wow, this is really easy. You go and you say something negative about a company, the stock goes down and you make money. And finding targets is one part of it. In other words, finding companies that have significant problems. But the hard part, especially after I've been doing this almost 14 years now, probably the hardest single part of the business end, the front of the house that you would see is understanding what investors will care about because not what's standing the rate increases that began almost two years ago and the market, the short-lived market correction from that, or at that time, since 2009, this emergency monetary policy that basically inured investors to risk and it's led to what I call a lie to me culture.

And there are other factors that contribute to that, such as the concentration of assets on the buy side because everybody became, all the allocators became worried about allocating to smaller fund managers post-Madoff and GFC. But basically, you have this mix where investors, equity investors really want, they're no longer remunerated for caring about risk for the most part. They want to buy narrative. So as an activist short seller, we sometimes, that's the hardest part is figuring out whether the issues we found with a given company are going to kind of pierce that bubble that investors can put themselves in where they try to ignore bad news. So that's the hardest part. Now, there's no shortage of companies with problems, and there are lots of companies that have problems that will clear that hurdle. But then you get to, okay, great, you've published, and companies are a lot more aggressive now about going after their critics and threatening to sue if not suing.

And they're doing that also with traditional journalists more often than they used to too. So, it used to be, when you go back to say 2005 or so, the big battle then was overstock.com and Patrick Byrne was the CEO. And for those of you who want to know how this guy turned out, he was one of the people who was in the White House in the final days of the Trump administration, urging Trump to call in troops and declare martial law to secure the election. So certainly I wasn't involved in 2005, but I think when you look back on that, this guy's clearly the whack job, but back then when he went after his critics and he filed lawsuits, a lot of shareholders felt negatively toward that as well, that's a distraction or there was also they’d protest too much. But now we're in a totally different environment where people cheer on the companies doing this, even if it's a complete waste of company time and money because it's very hard to win in the United States to win a lawsuit against an activist shareholder or an activist short seller.

So, the hard parts about this business are also now that you get sued more often, and regulators have kind of been, I'd say compromised by, or co-opted by the companies and their high-priced attorneys who used to work at the regulatory agencies, so you have to have a pretty strong stomach. Now that said, if you do and you can take the punches, it's an okay business. I mean, dollars per unit of brain damage and activist short selling are not good compared to being on the long side where we always kind of derisively say, it's close my eyes and buy right if I'm a long side manager. But it could still be a good business, but you have to do it because you really enjoy it and some part of you really enjoys the pot. So, in terms of the industry writ large, you have these cycles where it looks attractive and smaller players dip their toes in thinking, this is great and then they get hit with their first lawsuit and they're gone. But there are a few of us who've been around for a number of years, and I think we're doing well and we're robust, and just every day is new chance to try to bring one of these bad guys down to earth.

EMS:

Carson, it definitely is an exciting time in your space. Given that, I'd love to hear more specifics and some of the greatest opportunities you see and why.

CB:

We're not really thematic at Muddy Waters except in the rear-view mirror. But that said, I think Europe continues to be very enticing because Europe has a lot, within public companies, has a lot of wrongdoing and even blatantly illegal conduct. And so first, let me explain structurally why that is. So, notwithstanding Brexit, even with the U.K., people, money, material still move freely throughout the borders of the E.U. and U.K., but what does not is enforcement. So, when it comes to investigating and enforcing, it's entirely balkanized because there is no supernational regulator or investigative agency. So, you often have a company that's say, listed in France, or you could have a, for example, a company listed in France, legally domiciled in Luxembourg, doing bad things in Romanian, Hungary, run by Italians. Who's supposed to investigate that? And then when you get down to it, I do think that you have certain jurisdictions like Cyprus, Malta, and Luxembourg, that effectively realize that they need to look the other way to wrongdoing, because otherwise that's sort of their raison d'être in the modern economy.

So, with Europe, the wrongdoing is a feature, not a bug. So that presents a lot of opportunities to find these companies. The challenge is though, at least in continental Europe, and I say it this way because under Brexit, the U.K. is going to change this, but one of the things that probably the thing that makes shorting companies in Europe the hardest is the requirement that short positions that are 50 basis points or larger of the outstanding shares be publicly disclosed. That's one of the things that it discourages traditional short sellers as in non-activists from shorting stocks, but also a little bit harder, makes it harder for activist short sellers as well, because we'd want to build up positions larger than that before we speak. But if it goes public that we're short before we've spoken, trade is kind of over. So, Europe is interesting from that perspective.

And with the U.K. deciding to aggregate that public disclosure requirement, that could be interesting too. If we're going to be thematic. I think there's a lot for activist short sellers to do in Europe. There's a lot of filth. And in addition to the filth, there's also an investing culture there that very much discourages public criticism, public questioning. It's far more old boys club. We all know each other from way back when you're, you're one of us, I'm one of you, we're not going to embarrass each other. So, I think that's the other thing. And I guess the final cultural factor is, I mean, frankly in general, Europeans, especially continental Europeans, are lazier than Americans, which is saying something considering how little reading American investors seem to do. But that laziness means that problems that are hiding in plain sight remain hidden. So, again, great opportunity absent the public disclosure issue, as well as fact that continental European regulators will often step up and defend even complete dumpster fires of companies, as in the case of Wirecard in Germany.

EMS:

Carson, to shift gears a bit, I would love for you to address your outlook for ESG since that's been top of mind for the industry.

CB:

So ESG is something else that in the rearview mirror we've been thematic about. And I guess if I thought about it ahead of time, so when we see an area where a lot of money flows, there are companies that are in given space, maybe the early movers that are usually going to be okay or legitimate. But then you have all these me toos who are coming out there trying to chase those dollars, and they're often cutting a lot of corners. And they're not substantive companies in many respects. They're stock promotions many times. So, ESG as of a few years ago, had that characteristic where there's all this money flowing to it all of a sudden. So you had all kinds of grifters in charlatans coming out of the woodwork, but unlike, I guess that traditional area that gets hot, say like AI, right, this is an economy when you look at a lot of the ESG, or at least the environmental portion of ESG, it's an economy that's created by government subsidies. And what I hadn't really thought about before is that when you have that situation, I think it almost is guaranteed to turn into a major grift. And so, we've been public very critical of some of the solar companies, the rooftop solar companies, also company that provides financing to renewable energy, so-called renewable energy projects. I've thrown, so-called just because I've become so jaundiced by them and I think that nuclear is the obvious. If you want cheap, renewable, non-carbon producing energy, that's where you'd go. But putting aside that view, the issue is that I think a lot of the smaller players at the inception of this industry or a lot of the earlier players who weren't going to be aggressive in marking up the tax bases of their projects, that the companies that didn't do that, that said, no, that feels kind of dirty. I think they've got buried by the companies that weren't restrained and didn't care and that it really, I think when you look at an economy that's effectively created by and dominated by government subsidies, I think it's almost inevitable then that the winners are the ones who game the system the best. It's not the ones who provide the best product, the best service or the best value.

From that perspective, ESG will continue to be fertile because there's a huge subsidy grift that goes on, at least in the environmental space. And when people talk ESG, nobody cares about governance. I mean, let's be clear, nobody cares about “G” and “S.” I'm not even sure what that means. So, it's really about “E” as far as I think the public is concerned.

EMS:

Carson, we've covered a lot of ground today and wanted to see if you have any final thoughts you'd like to share with us.

CB:

Yeah, no, I mean, I've been pretty negative about a lot of stuff. But look, we, we've recently opened, or I shouldn't say recently, two-and-a-half years ago, we opened an office in Vietnam and we're just launching a fund to go long public equities in Vietnam. And the reason there is my background is in China, and it became clear to me about four years ago that the world was going to go through a major realignment, and it was all going to revolve around the various countries of the world's relationships to China, and that a lot of investment that would've flowed to China will go elsewhere. And we think the single largest beneficiary of that relative to the size of its economy and markets will be Vietnam. So, we are excited about Vietnam, and we're also excited about mining. We've been long, some mines. We're publicly disclosed long one of them right now. And we're subject of a long side activist battle that we're waging up in Canada, a very small mining company. But mining is another area that we really do like on the long side, so it's not all doom and gloom. We're happy to bet on dirt over people in the case of mining and happy to bet on the further demise of China on the world stage relative to other countries.

EMS:

Carson, I want to thank you so much for sharing your perspective with our listeners.

CB:

Thank you.

EMS:

And thank you for listening to the EisnerAmper podcast series. Visit EisnerAmper.com for more information on this and a host of other topics. And join us for our next EisnerAmper podcast when we get down to business.

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