Sea change of a renowned short seller

The world's most famous short seller is happy to leave the job of holding to account the market's frauds, pirates and charlatans to others.

Bill Ackman's recent performance has been spectacular and he is eyeing other prizes these days.

He is behind one of the world's biggest and for now, most mysterious, Special Purpose Acquisition Company vehicles, which are being tipped to circumvent the Wall Street fanfare of going public.

“The results have been great. And life is good. And I'm happy,” says Ackman, the headline act of the upcoming Sohn Hearts & Minds charity event, where the world's best investors share stock tips for charity.

Ahead of that appearance, the market is speculating, but not about which company Ackman will target with a forensic takedown.

“We really don't short stocks. It is not what we do for a living,” he says.

Rather it is which private business he might snap up with the $US4 billion ($5.6 billion) he raised via a Special Purpose Acquisition Company – with terminal business Bloomberg and accommodation disrupter Airbnb among those linked with an Ackman play that would effectively take them public.

In a Special Purpose Acquisition Company, a structure hardly used in Australia, an investor raises money for a so-called blank cheque company, retaining a portion of equity, with a certain time frame to purchase an asset.

For companies that want to go public, striking a deal with a SPAC is an alternative to an initial public offering. It saves time, money and some of the complications involved.

As an activist, Ackman is a divisive character on Wall Street.

He has rubbed executives the wrong way with extensive campaigns in which he’s taken both long and short positions, at times putting him in conflict with other investors.

The policemen of the marketplace are the people who do short research. Regulators clean up after the company melts down, after the fact.

— Bill Ackman

Ackman also has a nemesis of sorts in the form of Australian hedge fund manager John Hempton, who took the opposite bet on two of Ackman’s unsuccessful trades: a large position in Valeant, and a short bet on Herbalife. Both went badly wrong, wiping an estimated 30 per cent from his portfolio.

Ackman still disagrees with the Bronte Capital manager about Herbalife, and points to several regulatory issues that have since come to light which Ackman and his company Pershing drew attention to.

“Unfortunately it shows that a bad company can, with good lawyers and a good balance sheet, continue to exist.”

Ackman says he invented the activist short when he wrote a three-part series on a company called Farmer Mac almost 20 years ago which he described as an “effective, and positive experience”.

Now they are more common, which he believes is healthy for markets in striving to keep companies honest.

Short activists typically seek to expose overvalued or fraudulent companies via research reports that they make public in the hope of encouraging investors to sell or short shares in the company based on the findings. While most reports are authored by funds or known analysts, occasionally they are published anonymously.

“The policemen of the marketplace are the people who do short research,” Ackman agrees. “Regulators clean up after the company melts down, after the fact."

He referenced the Wirecard disaster in Germany, which evaded the scrutiny of regulators for years, before imploding in spectacular fashion. Its former chief operating officer is still on the run, and in the meantime, regulators, brokers and amateur investors had waged a campaign of intimidation on the Financial Times' investigative reporting.

"If you look at the Wirecard situation in Europe the regulator went after not just the short sellers but the Financial Times," Ackman says, alluding to the injustice of the situation.

But Ackman says there’s a darker aspect to short research too: “There’s a lot of Mickey Mouse stuff that happens that is totally inappropriate. There are cases where companies are materially harmed and it turns out the short sellers are wrong”.

Short reports are often fronts for more powerful or just less transparent forces, he says. Sometimes the authors are quietly backed by hedge funds who have put on a trade or compensate research firms for their work. Hedge funds also hand off their own work to others to publish anonymously.

“That raises a whole bunch of interesting regulatory issues.”

He says he understands why short reports are authored anonymously: “You get attacked and come under all kinds of scrutiny. Is one better off just doing the work and putting it out anonymously?”

However, Ackman and Pershing are no strangers to confrontation. He is probably Wall Street's most recognisable agitator, naming names and putting his claims on the record.

Ackman says his Herbalife trade was a one-off consumer protection play, and he did attract a lot of publicity to a company he believed to be "a pyramid scheme”.

His first big scalp was MBIA. In 2007, after a years-long campaign, he was finally vindicated. MBIA would buckle during the sub-prime mortgage crisis, and its triple-A rating which Ackman jousted with the ratings agencies over proved worthless.

Today, with his mysterious SPAC in the wings, perhaps Ackman has outgrown punishing short activism.

He says it could be because he’s turned 50 or because he’s remarried and become a father again, but his energy is focused on finding “great companies with great management teams” or “bringing in new management talent” by being an activist long investor.

“I respect short sellers but you don’t make a lot of friends in the short-selling business. It requires a very thick skin.”

Other investors that have joined Ackman on his short crusades have also found the animosity can come at the expense of returns.

Guy Spier, who initially embraced the rough and tumble of short selling, also turned his back on activist short selling after also betting against Farmer Mac.

It was Ackman who convinced Spier to turn a long position in Farmer Mac into a short, solidified after an evasive meeting with executives.

But his short bets against government-sponsored entities attracted the attention of then attorney-general Eliot Spitzer. Spier turned his back on short activism even though the facts vindicated the research.

“My goal as an investor is to compound money for my shareholders, not to pick unnecessary fights or conduct myself like an avenging moral crusader,” Spier wrote in his book Education of a Value Investor.

Analysts' dilemma

Therein lies the dilemma of the sceptical analyst. To steer clear of conflict and focus on investor funds or act on what they believe is in the public interest and bring corporate malfeasance to light.

“As I see it life is just too short for this sort of conflict and these investment gains didn’t justify the headache,” Spier said. “In my experience, it's karmically better to focus on the positive . . . instead of getting embroiled in acrimonious battles.”

The Herbalife short was one of two major forced errors that cost Ackman and his investors.

His other major misstep was Valeant Pharmaceuticals. The Canadian drugmaker once a market darling, memorably fell 50 per cent in a single session following an earnings restatement in a string of controversies relating to its accounting methods and relationship with specialty pharmacies.

He says the mistake from both was that he deviated from the core principles of his investment strategy.

While Ackman may have sworn himself off short selling, earlier this year he nailed his big short in the form of a complex credit derivative position in the eye of March’s pandemic storm.

In February, Ackman effectively took a bet that the credit market would crater through buying insurance on an index of derivatives tied to corporate debt. His fund was effectively on the hook to make $500 million of premium payments a year.

In the end, given the short duration of the trade, he paid $27 million of premiums but bagged a $US2.6 billion profit as credit spreads spiked.

“It was one of the most asymmetric low downside, big upside situations I've ever seen but there's nothing without risk.”

Ackman said it was a low-risk trade because he did not intend to keep it for long, and would know within a short time frame whether their view on the virus was right or wrong.

“That's what created the asymmetry. I could not conceive of a scenario in which a virus spreading around the world would cause people to be more comfortable about buying corporate credit.”

That index trade delivered a 39 per cent return for investors. That along with investments in Chipotle, Restaurant Brands International, Starbucks and Lowes helped Pershing to a 56 per cent gain this year, following a 58 per cent return the previous year.

Those disasters now seem a distant memory.

This article was originally posted on The Australian Financial Review here.

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