Unconventional Idea Generation

A former classmate of mine (who was fairly popular) seems to be the ultimate short idea generator (all his employers ended up being exceptionally great shorts). If you look at his resume, he looks like the guy you’d want to hire… I’ll let the world (and the all-knowing head-hunters) believe that. As far as I’m concerned, he’s an incredible idea generator. For short ideas…

Employment history

2006-2008 - Bulge-bracket, “too big to fail” investment bank (phenomenal short)

2008-2009 - Private equity (phenomenal short)

2009-2011 - Obama Administration - Clean-tech investments (phenomenal short… think Solyndra)

2011 - GroupOn (Phenomenal short)

2011-Present - Mobile/Social Commerce …. 

Originally posted on May 31, 2013

::UPDATED:: June 3rd, 2013

It seems that a certain Carson Block, and Muddy Waters Research LLC  (directionally) agrees:

It (Silicon Valley) has “a lot of truly innovative companies, but there are also a number of companies in the Valley that are more pretenders,” he says, adding that tech companies won’t be Muddy Waters’s exclusive focus.

Though we share a coincidental interest in tech companies (that may or may not be HQ-ed in Silicon Valley), Salesforce.com’s recent acquisition makes you really wonder.

The Great Frauds Are Not Relics of the Past - History is Doomed to Rhyme

Two people, whose opinions I respect very much, independently made the following claim to me recently: “The great frauds of the late 1990s/early 2000s (Enron, MCI-Worldcom, Lernout Hauspie, etc) are a thing of the past… those types of frauds are likely never to happen ever again.”  My gut reaction to their belief was that they are wrong, and I told them as much (isn’t it ironic these two made this claim, just as US markets hit all time highs?). Rather than relying on my instincts, however, I decided to look into the evidence.

To sum it up: the evidence does not support their opinion. Look no further then the fraud implosions of the  2006-2008 period as proof that falsifies the belief that the late 1990s/early 2000s somehow marked the end of the great frauds (not to mention, there have been some more recent frauds as well).

Some of  you may wonder, “So what? That’s all in the past.” Others will wonder, “Why? Why didn’t Sarbanes Oxley, etc. prevent some of the fraud-driven implosions from occurring in 2006-2008?” I will not discuss the “why” question, but I will express the following opinion:

I believe we’re entering a period where we will see a wave of some truly great fraud implosions (like we did in the late 1990s/early 2000s), within the next few years.

The following is a summary of my research (I tend to focus on how to monetize via single names, which I do not cover in this post):

  • Macro Matters - Frauds seem to unravel (come to an end) in cycles, usually clustering around market corrections/crashes. We’re due for a correction, and the faster and higher we go, the greater the risk of a disruptive crash.
  • Short Sellers, Whistleblowers, and Regulators Matter - Frauds are less macro dependent when  (1) regulators do their job (i.e. enforce existing rules) (2) short sellers speak out &  are taken seriously, and (3) whistle-blowers act . When short sellers/regulators/whistleblowers win, absolute return investors/speculators win as well, as fraud stocks decouple from the overall market.
  • Poor Regulation/Enforcement Increases the Frauds’ Correlation to Macro - Frauds seem to become pro-cyclical when regulators are complacent, incompetent, or (in some cases) corrupt. In these cases, frauds grow larger and last longer than they otherwise would/should have. Adds to market instability, volatility, and reduction of confidence.
  • The Short Sellers’ Pain, is No One’s Gain  - Going long highly shorted stocks has been a very fashionable trade since Q4 2012. Yet history clearly shows that “get shorty” is not the path to long-term prosperity… “get shorty” almost always precedes market corrections/crashes (the sole exception to this seems the beginning of a secular/structural, multi-year bull market; and if you believe we are entering one, I encourage you to express your views accordingly). If you try to get shorty, the market will get you. And then some.
  • Vilification of Short Selling and Free Speech Precede Market Turbulence - If you think it through very carefully, short selling is a form of free speech (a subset, if you will). The ridiculous and absurd vilification of Rocker Partners by Overstock.com/Patrick Byrne, and Greenlight Capital by Allied Capital and the SEC… well, those things occurred 1-2 years before some serious market volatility. If you think “this time is different” … time will tell.

What Investors/Speculators Should Do

  • Limited Partner types (Endowments, family offices, pension funds, etc) should start adding exposure to funds with short selling expertise… there aren’t that many out there. This can come in form of net short/short only, long/short, volatility, credit, event-driven, special situation, opportunity, and even macro vehicles. The key is finding a fund that has a natural short seller on board (short sellers are probably born, not made; many famous short sellers have said as much). Even better if the person at the top (the head PM/CIO) is a short seller, who has subsequently branched to do other things. Those who tout AMZN as shorts are to be avoided…as they’re not short sellers (a red flag). They are closet value, long-only  guys looking to “learn” how to short (at your expense), and justify 2 and 20 compensation structure.
  • General Partner types (hedge funds and family offices) - Most professionals in the hedge fund world are blessed with not possessing the short seller “gene”. You might want to start looking to add someone who does though. You will likely have to throw out your normal hiring criterion: most of the great short sellers have very… non-traditional backgrounds, especially on paper. A few look kinda, sorta normal on paper, but the vast majority don’t. Just take a look at the Feshbach Brothers, Citron Research, Muddy Waters Research, and many others, to see what I mean.
  • Do your own homework, and/or spend the necessary $ and time resources. There’s a fine line between being cheap, and being stupid. You buy insurance when you (think) you don’t need it. You’re smart to buy insurance when it’s cheap (when valuations of the lying are higher, not lower). Compare buying index options, short ETFs, vs. paying a short seller with an inverted 2/20 structure (see Kynikos). You’ll find that it’s actually cheaper and more effective (in the case of short selling, not all hedge funds) to pay a short seller, rather than do it yourself.
  • Be a risk manager, not a career risk manager. Investors seem to, time and time again, buy insurance at market lows, and sell insurance at market highs. The ever trend-following types, added short exposure in late 2008/early 2009, not 2006/2007. In 2001/2002, not 1999/2000. You don’t have to follow the crowd, if your goal is capital preservation AND enhancement.
  • Consider reducing exposure to funds that have performed exceptionally well the last few years.

On a lighter note: word on the street is that women make just as good (if not better), short sellers as men.

::UPDATED:: 2013 05 29

Here are a few things that contextualize why I believe that history is doomed to rhyme:

(1)  “Covenant-lite” loans have soared to more than 50% of all loan issuance so far this year, twice the level seen during 2007”

(2) SEC accounting focus returning - “Congress also added to the SEC’s responsibilities when it passed Dodd Frank. So Congress both gave the SEC more to do and fewer resources.” -


(3) Harvard study shows high levels of cheating (i.e. bad behavior is omnipresent wherever there is “pressure, opportunity, and rationalization” - the fraud triangle… Harvard isn’t the problem; it’s merely a microcosm) http://www.thecrimson.com/article/2013/5/28/senior-survey-2013/?page=single#

(4) Free speech and media under threat ( and a badboy from the Allied Capital days holds position of power) -

U.S. Attorney in Phone Leaks Has Seen Both Sides - http://www.nytimes.com/2013/05/21/business/us-attorney-in-phone-leaks-has-seen-both-sides.html?pagewanted=all

Leak Inquiries Show How Wide a Net U.S. Cast - http://www.nytimes.com/2013/05/26/us/leaks-inquiries-show-how-wide-a-net-is-cast.html?pagewanted=1&_r=0&adxnnlx=1369505313-YF0G3tpKU8tum4wASCh6yA

Press Sees Chilling Effect in Justice Department Inquiries -  http://www.nytimes.com/2013/05/25/us/politics/reporters-see-chilling-effect-from-justice-dept-inquiries.html?hp&_r=1&

(5) Skyscrapers…gotta love them skyscrapers -  http://www.businessinsider.com/skyscrapers-that-predicted-financial-crises-2013-5?op=1

If LOTE Can Do It, So Can You! (Until the Regulators Come Knockin’)

In case you were wondering, here are the facts concerning Lot78 Inc:

  • ~$1 billion market value as of 5/21/2013 close.
  • $0.5 million in ANNUAL revenue (that’s right, something like 2000x revenue), DOWN from prior year.
  • LOTE borrowed $40,000 (yes, that’s not a typo) from its founder just to stay in business.
  • LOTE’s auditor expressed doubt on its chances of survival.

And there’s plenty more.


Now some of you might wonder, how is the stock up? Here’s a theory:

“box job” - promoters obtain hidden control of the entire supply of a public company’s securities creating a a secret monopoly. Control of the shell corporation and its stock is concealed by the use of nominee officers, directors and shareholders, who hold their stock in their own names, but are secretly controlled by the promoter. Hidden control of a public “boxed” shell company is a very valuable commodity, one that can be sold to unscrupulous individuals who use this hidden control to manipulate the company’s stock price. (loosely quoted from a random DOJ brief)

Source: seekingalpha.com/article/1394981

We’ll leave you to think through the moral and legal consequences, if true…


Claim: Wellington Management Raises Their Unipixel Stake to 14%, Therefore Unipixel isn’t a Fraud

Penny stock pump and dumps are somewhat of a guilty pleasure of LST… so enter Unipixel (“UNXL”), a ~$300 million market cap stock with the following characteristics that a long-term investor would love:

(1) $16 million in total assets (of which $12 million is recently infused cash via an equity raise)

(2) a management team with a long history of failure/capital misallocation

(3) Price/Sales multiple in the 3,000-4,000x range

(4)  Laundry list of other red flags

UNXL has nevertheless returned over 400% to shareholders within just 1 year. 

Despite the stock’s impressive performance, an SEC filing yesterday showed that Wellington Management increased their stake in UNXL to 14% stake up from 5%, essentially indicating they expect more upside. To the unexperienced market participant, this would seem to support the prevailing belief that the critics’ concerns (and laundry list of red flags) are much ado about nothing. The market is efficient, it discounts all information, big money is smart money… right?

LST believes that facts speak for themselves. Here are a few facts about Wellington Management’s track record, when it comes to frauds:

Sino-Forest Shares Surge After Wellington Management Discloses 11.5% Stake - Bloomberg News July 5, 2011 (Sino-Forest’s price today: $0.00)

And if you think Sino-Forest was an isolated case for Wellington Management (after all, we all make mistakes), here’s an excerpt from Six Big Investors Who Lost Big on China :

The gigantic investment manager Wellington Management has made some pretty hefty bets on a number of Chinese stocks that are now halted or delisted. The firm built an 8.2% stake in China-Biotics, the yogurt-culture company in Shanghai, despite the fact that China-Biotics had spent the previous year defending itself against report after report by short-sellers and the Chinese media alleging that the company isn’t what it says it is. The Nasdaq exchange halted trading in China-Biotics last week after it failed to meet the deadline for filing a 10-K report with the SEC.

But it doesn’t stop there for poor Wellington, a spokesman for which declined to comment. The firm holds 5% of Jiangbo Pharmaceuticals (JGBO), whose shares have been halted since May 31; 3.7% of Yuhe International (YUII), a provider of “day-old chickens” whose shares were halted on June 17; and 2.2% of Puda Coal (PUDA), whose shares were halted on April 11.

Wellington also recently unloaded an 800,000-share position in China Electric Motor (CELM), a company whose auditor resigned after finding alleged irregularities. CELM was delisted by Nasdaq earlier this month.

If you’re long UNXL, you should be fearful that Wellington has bought into UNXL. The real question is: whoever the analyst/pm that ultimately pulled the trigger… are they just simply uninformed “believers” in UNXL (cults exist too), or are they the slick/cunning variety  trying to orchestrate a short squeeze (ignoring the moral and legal considerations) ?


CRM: 200+ before 100? Why it’s on the Radar and Why LST is Not Short It (Yet?)

Salesforce.com (“CRM”) to equity guys isn’t quite what the Yen has been to macro guys, i.e. the “widowmaker”, but it might be getting there.  It’s a stock and business that many people love to dislike, and always think a crash is imminent. Yet it’s continued to ‘climb the wall of worry’, with no end in sight. While CRM is back on LST’s radar and higher up in priority now, LST is hesitant to short here and now, for the following reasons:

The reasons LST does not like CRM from the short side here (from a purely alpha, not beta perspective):

  • It’s not clear why CRM can’t generate ~$3.0 billion in revenue, & trade at 10x that, in the near future. That would take the stock north of $200/share.
  • There is a high interest in shorting CRM (short interest and sentiment wise) - this means there is always a non-negligible risk that that itself will invite unscrupulous marginal buyers who will try to pressure the shorts out. The offsetting factor to that is CRM is large enough now, whereby even with high institutional interest in shorting, the pie is large …
  • ‘Big data’ and ‘cloud’, as gimmicky as they may sound, seem to represent real secular business trends. Why short into growing industries? Investment implication = Overvalued can become more overvalued, or at least remained similarly overvalued on the back of growing revenue. If your belief is that revenue will slow, if not reverse, that’s an entirely different story. But LST is not in the business of glorified coin-flipping.
  • The short/skeptics’ arguments sound lazy/recycled, at least upon first glance. (Valuation this, earnings that, blah blah blah).
  • If the acquisitions in 2012 are being used for nefarious purposes, that can work against you for now, unless you believe in some hard catalyst-induced implosion.
  • Its stock price is high, so it’s relatively cheap for CRM to buy moar revenue…
  • Some technical/chart types are attracted to it because the technical/charts look good to them…which can be violently self-fulfilling.
  • Unclear what the acquisition risk is, albeit it would be a strong contender for the AOL Time Warner of our time, if it were to happen.

Having said all the above, CRM looks a lot more interesting on the short side to LST currently than it did in 2011 for various reasons, which LST may or may not publicly share at some future point. Note that LST always reserves the right to “trade first, analyze later”, but the above list of concerns is no small one. Unlike ‘work’ in introductory Physics, shorting is a highly “path-dependent” endeavor…

2013 Counterintuitive Investment Theme #1: Betting on Paulson (?)

Thesis: Paulson & co’s failed trades in the last few years have tended to perform remarkably well in subsequent years. LST believes short Europe and/or long gold miners may present compelling reward vs. risk at some point in 2013 (if not now). So:

(1) Betting against Europe - Short a basket of EUR, short European sovereign bonds, and long European CDS.

(2) Betting on Gold Miners - The majors and the juniors, e.g. AU, NG, GFI (without loss of generality).

LST will likely do more work (it’s still in idea generation/evaluation stage, granted LST sometimes adheres to the “trade first, analyze later” philosophy a la Soros), possibly updating this post. Let’s examine the case against (1) and (2) (LST prefers the dialectic/socratic approach, rather than the more traditional b-school model where you start with your ‘case for’):

Case against / Counterarguments

(1) Why bet against Europe?

  • Europe is structurally flawed, but the problems are known, priced in.
  • Eurozone has stabilized, low rates are buying time for at risk countries such as Spain to solve its structural problems, e.g. employment.
  • The markets seem to respond favorably to incremental actions by the ECB.
  • The banking sector has been stabilizing, the systemic risk indicators are all pointing to calm.

(2) Why bet on gold miners?

  • The smart macro money is short or looking to short gold (their models say so!), confidence appears to be rising, as the Fed is giving some hope that QE and other “extraordinary” interventions will slow, if not start to reverse. The reflation trade in reverse…
  • Inflation in labor, fuel, etc. would not be good for margins.
  • “The risk premium goes up when the gold price goes up. Societies are more envious of your gold at $3000 than at $300. And there is no valuation argument that protects you against the risk of confiscation.” (Hugh Hendry)

LST wonders if the EUR USD needs to go higher - say 1.40 - before it’s time to short Europe. Similarly, LST wonders if gold needs to see a more meaningful correction (with similar pain in the miners) before going long gold miners.

Deconstructing the case against/counterarguments - LST is not sure yet, needs to gather more information, and think this through more. Having said that, LST likes the short Europe idea as LST can’t recall the last time Europe dominated the headlines.

On the Radar for 2013

These are the areas that currently interest LST, as we head into 2013:

(1) Frauds, Fads, & Failures - Never gets old. While these tend to be inherently of a single-name (and occasionally thematic) nature, it appears there are certain markets where macroeconomic froth/excess may intersect with the three Fs. Those remain of highest priority. Oh, and “activist” shorts are always high priority.

(2) REITs - This is an area where LST feels (relatively) comfortable, as far as getting up to speed, both on a macro and single-name basis. Will be (particularly) on the lookout for the crescendo of foolish, uneconomic, and short-term behavior. It seems markets all too often forget that “innovation” and “creativity” in finance (e.g. the REIT-ization of “non-traditional” names) are euphemisms for “hidden debt” and “hidden risks” and…all too often end in tears.

(3) Special Situation Longs - Names such as CNSI (as inspired by @mojoris1977 ) will take top priority. IRBT, INVN, and a few others are on the evaluation pipeline. Finally, will be monitoring acquisition and/or activist worthy names.

(4) High Yield Credit - Per one of LST’s recent posts…

(5) Japan, the Nikkei, and USD JPY - The recent performance of the USD JPY and Nikkei have gotten the attention of even lowly students of macro jazz such as LST.

(6) IPOs (particularly of the tech variety) - A few sources “familiar with the matter” expect that tech IPO land will be quite busy in 2013. Time will tell, but if supply increases in equity land, LST will be a very happy camper…


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