IR in a Short-Selling Environment

Short selling has been an investing strategy for hundreds of years. Thought to have been first employed in Holland in the early 1600s, it has grown in popularity in recent times due to the rise of hedge funds and their alternative investing styles.

Although there are multiple variations, the premise works like this: short sellers borrow the stock of a public company, sell it into the market hoping the company falters, then buy the stock back at a lower price, pocket the difference and return the shares to their rightful owners.

It is a high-risk approach that can create or destroy the fortunes of those using it. It is also one that is decidedly unpopular with every management team whose shares have been shorted, particularly when the short seller promotes a doomsday scenario for the company, its prospects, its disclosures and the veracity of its leadership.

In this issue of IR focus, we look at some of the common practices of aggressive short sellers and some of the countermeasures used by IR teams to fight back.

The Short Seller Playbook

Many companies attract the attention of short sellers but not all encounter the full court press used by some of the most aggressive. Aggressive actions that are typical include:

A media ‘whisper’ campaign that prompts well-known journalists to write negative stories about a company, and its valuation;
Televised interviews with news organizations where the short seller makes a case against a company, usually using colourful and inflammatory language;
Constant Twitter feeds criticizing everything from the CEO’s pay packet to the company’s accounting practices;
Meetings with and phone calls to a company’s largest ‘long’ investors to scare them into dumping the stock;
PowerPoint presentations using a company’s logo emblazoned on a sinking ship followed by slide upon slide examples of a company’s shortcomings, including missed estimates, failure to make timely disclosures and errors or omissions in reporting; and
Active participation in quarterly earnings calls – sometimes using a pseudonym to bypass screeners – which they use as a platform to promote their arguments and belittle management in the process.

It is a nasty business, so what can IROs do when short sellers come calling?

Pay Close Attention

First, you need to keep track of short selling activity in your stock. This is possible using data from a number of providers. Increases in shorting activity is a warning sign and some companies have found themselves in the unenviable position of discovering that every single share available to be borrowed has been sold short.

As shorting activity increases absent a decline in the share price, or as some well-known aggressive shorts take positions, get ready for an attack. When this happens, it will be difficult to read or listen to criticism – some IROs have described it as watching a train wreck unfolding – but it is vital to absorb everything that the short seller says about your company. Understanding the short seller’s investment argument will allow you to refute it. So by all means, follow the short seller’s tweets, ask your investment banker to copy you on any ‘research’ that the short seller publishes and watch the news media for overtly negative stories on your company.

Separate Fact From Fiction

Much of what short sellers write is speculative. For example, among the favourite targets today are mortgage lenders because of the perceived risk of a real estate downturn. Short sellers will use the underlying market risk to postulate that today’s small rise in mortgage arrears on a company’s books will lead to large increases in loan losses in future periods and therefore destroy a substantial amount of shareholder equity. To support their argument, they will dissect the company’s results and draw the least flattering conclusions, using the financials to do so. This is the opposite of the positive ‘spin’ that public companies are often accused of using.

In a free country, such speculative posturing is fair game and the ultimate line of defense is to prove the short sellers wrong by producing results that refute their suppositions.

In the meantime, review the short sellers’ math to see if the conclusions drawn can be supported. If nothing else, short sellers do their homework, but sometimes they misunderstand key terms and/or use the wrong disclosures to draw conclusions. If you find errors in their line of thinking, there are two options. Call the short sellers on it and/or let your key investors know.

Calling short sellers out through private confrontation is likely pointless as they will not cease and desist their broader assault. Their single-minded pursuit is to drive your share price down. They have significant capital at risk – to say nothing of the fees they pay to borrow stock (fees that increase as stock available to short decreases). Therefore, nothing you say is likely to change their positions. As well, any private discussions you have will likely find their way into the public domain as the short sellers attempt to use your words against you.

Calling short sellers out in public is also not a favoured strategy as it gives them the type of attention they crave, although there are times when short sellers’ claims are deemed so egregious they warrant a formal news release in response (see http://concordiarx.com/release/?id=122551) and/or a scripted rebuttal in a quarterly conference call (see https://event.on24.com/eventRegistration/EventLobbyServlet?target=registration.jsp&eventid=1060132&sessionid=1&key=762A8E2E6683040C36E42F9903CAA7FB&sourcepage=register).

Refuting these lines of attack when speaking privately to ‘long’ investors and debtholders is a worthwhile exercise as it should remove seeds of doubt that short sellers are attempting to sow. Be careful in those private conversations not to selectively disclose any material facts e.g. imminent good news.

Beyond ‘legitimate’ commentary, some short sellers engage in personal attacks on the character of the CEO, dredging up past business associations and using inflammatory language to suggest incompetence or worse. This is one of many reasons why CEOs do not enjoy the profile that comes with leading a public company.

Fighting back using legal means is one option, if the allegations are seriously defamatory, but doing so is costly and it should be noted that a lawyer’s cease and desist letter is sometimes used by short sellers to suggest the CEO is running scared and resorting to muzzling techniques.

Choose Your Words and Disclosures Carefully

Powerless – at least that’s how IROs whose companies are in a short seller’s crosshairs might feel. However, that is not the case. When short sellers act aggressively in the public domain, it is more important than ever to keep in close contact with your largest long investors and sell-side analysts. The sell side can be a credible and effective third-party ally in publishing research and making public (and media) statements refuting short-sellers’ claims.

An equally important role for IR is to vet all corporate statements through the eyes of the short seller. Understanding how the short seller will use (and abuse) corporate information will help you to craft effective key messages and disclosures that are hopefully less likely to provide fodder for negative arguments. As always, being as transparent and timely as possible in communicating is the best defence. In circumstances where short sellers misinterpret disclosures or key financial terms, take the time to explain those terms and how they are calculated; do so in the MD&A and/or in forums such as quarterly conference calls, so as to remove any confusion.

Media relations will also take on greater importance and your company needs to be able to decide quickly how to respond when asked for comment (standby messaging is valuable for this purpose) and when/if to proactively seek out media coverage.

Short sellers’ attacks can also destabilize customer and supplier relationships and create uncertainty for employees. IROs can play a role in assuaging these concerns by working with public and employee relations counterparts.

While capital market experts will argue that short selling is a necessary part of setting the appropriate price for a security, there is nothing better than being on a corporate team that is able to prove the short seller wrong. In the end, it will take good corporate performance to send the short sellers packing, but in the meantime, IROs can play a constructive role in helping their companies to navigate what can be a nasty side of capital markets business.

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