VICTORIA GEDDES, EXECUTIVE DIRECTOR
Two years ago we wrote an article on a well-established activist strategy in the US called the “short attack”. In Australia we are very familiar with short selling as a legitimate tactic to deliver portfolio performance but short or bear attacks are something else altogether. Equity markets and investors received their first taste of what was to come in March last year with the well-publicised attack on sandalwood producer, Quintis, by US based Glaucus Research Group. Quintis is now in administration and subject to several class actions.
At the time, Glaucus promised (like Arnold Schwarznegger’s Terminator) that “they’d be back” and almost a year to the day they have launched their second offensive on the Blue Sky Alternative Investments Fund. Aside from the Quintis example, targets have good reason to be worried. Of the 30 or so companies targeted by the firm since 2011, only four have share prices higher than at the point of Glaucus’ report being released.
As the following article (a rerun of our 2016 blog) highlights, there is little that Glaucus is doing that strays far from the short attack playbook. The positive take from this is that companies can and should prepare themselves, in much the same way as they would for a cybersecurity attack.
So What is a Short Attack?
Those who have been on the receiving end of one of these attacks describe the process as akin to being at war, with the company’s very survival the ultimate goal. The Attacker is taking direct aim at the company’s revenue stream, the regulators and the providers of capital with the objective of inflicting maximum damage on the company in order to deliver a profit on their strategy. It is a game with extremely high stakes so there are valuable lessons to be learned from those who have lived through such an experience.
So what makes a company an attractive target to short attacks? In the US, where these types of attacks are more prevalent than in Australia, the analysis suggests some common characteristics. The company:
- has shares which tend to be closely held
- is highly valued relative to its peers
- tends to operate in a highly regulated industry
- has a history of making acquisitions or specialises in complicated, complex strategies
The attack component of this strategy reflects the fact that before a Shorter approaches its target, it will have already marshalled backing forces with the necessary fire power to inflict damage – most typically hedge funds. They will then start to seed doubts about the company’s management, performance, credit-worthiness and strategy through the media, including social media, the ratings agencies and analyst community. White papers may be written and websites set up to prosecute their argument but more often than not it is simply a process of rumour mongering. A common tactic is to play on the emotions of management and the board – making false claims about senior management and directors, sowing the seeds of doubt in the minds of investors and shareholders about their competency and integrity. The toll on individuals can be very real and companies need to be prepared for the fact that these strategies can often play out over months, rather than weeks.
There can be tell-tale signs that something unusual is happening if companies make it their practice to be tuned into what the market is saying about them. Current and former employees are often contacted, as are customers, shareholders, vendors and brokers all of whom are likely to ring the alarm bell by reaching out to the company with questions that are atypical of what would normally be asked. Also monitoring the equities and options markets closely to identify potential short seller activity should be part of the company’s regular reporting protocol.
Response Strategy for Short Attacks
Companies need to defend themselves against such attacks with the same level of organisation that they would apply to a hostile takeover or a cybersecurity breach. This includes resourcing up by hiring external advisers – typically this includes IR firms and legal counsel with experience in these situations. This ensures that management are not distracted from running the company, a key objective in the Short attack strategy which is entirely focused on undermining the company’s operational performance.
The development and execution of a communications and IR engagement strategy is critical to managing the company’s defence against the attacker. Indeed constant, targeted communication with key stakeholders, excluding the Attacker, is really THE only effective defence. Some useful tips include:
- Once the attack is on, don’t waste any time getting on the front foot
- Communicate often and to every constituent who might be watching what the short seller is saying about the company
- Contact investors and analysts to address all the short seller arguments and positions
- Enlist the support of shareholders to come out and refute the short seller’s statements
- Put everything in writing – when the company is asked to comment by media or the Shorter, request the questions and provide a written response. Post the Q&A to the market to pre-empt any false statements being made without reference to the company’s official response
- Remove shares that are available to short sellers to implement their strategy
- request major shareholders stop custodians lending their shares. This makes it both difficult and, more importantly, expensive for the Attacker to borrow the company’s stock
- implement a share buyback scheme (if the attack goes on for an extended period of time, which many of them do)
- Finally, think carefully about the risks and benefits associated with taking legal action which is costly, time intensive and will further publicise the short sellers’ allegations. Companies also expose themselves to the risk of sensitive company information being revealed during the discovery process as well as drawing additional scrutiny and unwanted attention from market regulators.
But pick your targets
The consensus with those having been through this experience is that there is no point trying to talk to the Shorter. They are not open to persuasion or compelling arguments essentially because their goal is clear – to inflict maximum damage on the company – and nothing the company says is going to distract them from it. Gerry Harvey acknowledged this at the Harvey Norman AGM but immediately lost the moral high ground by telling the mysterious foreign short seller to ‘piss off’ and stop spreading ‘hearsay and rumours’. He effectively rose to the bait, guaranteeing widespread media coverage of the Shorter’s allegations.
So while media is definitely a participant in this process, there is reason to be cautious about proactive engagement. As a general rule, companies should respond as needed to defend their position against blatant misrepresentation of the facts. However, as Gerry Harvey found to his cost, the media is less likely to be interested in prosecuting the company’s reasoned viewpoint than it is to reporting the company’s outrage or sensational allegations of the Shorter because they provide copy that is so much more ‘news worthy’. It is not unheard of for shorters to use social media tactically to develop momentum around their story, including creating multiple personalities online each of which supports and promotes the argument being prosecuted.
In summary, this is not a good place for a company to find itself in. While there is no standard playbook for companies to follow there is no excuse for not having the essentials of a response plan in place, even if there is no sign of active shorting in the stock. Short sellers generally try to evade detection precisely so that they can catch the company off guard.
Once a short seller has revealed its hand the damage is immediate regardless of whether the allegations have any substance. At this point the skillset associated with issues/crisis management is often the most relevant. The most effective tool available is to communicate loudly and often to every stakeholder in the company to counter the stories being peddled by the Shorter who has only one outcome in mind. Short attacks are rarely over quickly so establishing a strategy that will serve the company over a long period of time and resourcing up appropriately with external advisers who have the relevant experience and can provide an objective, independent perspective is critical. The goal is to keep the company together, maintain morale and ensure it survives.