«Over time, the short-selling community has been decimated. Good short-sellers have become an endangered species», says Marc Cohodes, here posing in front of the sculpture «Thinker Bull» in Barcelona.
When Marc Cohodes takes aim at a company shareholders better take their money and run. “When I find wrongdoing or fraud I will do everything to expose it”, says the combative short-seller from California. With his investment style he is one of the increasingly rare financial specialists who are betting against stocks that they think will decline in price. The former boss of the hedge fund Copper River Partners, who now works on his own, gives a glimpse into his skillful profession and tells how he spots overvalued companies. These days, he focuses mainly on Canada where he sees opportunities because of an even bigger real estate bubble than the one during the US housing boom.
Mr. Cohodes, in the world of finance, short-sellers don’t necessarily have the best reputation. How come?
I’m proud of my role in the market and I’m proud of other people who do what I do. Legitimate companies who do good things, which is by and large the majority of companies, usually don’t know who the hell I am. On the other hand, if you’re a company and you’re well aware of me, chances are you’ve done something very wrong. So people who are doing wrong things, who have things to hide and who don’t like to be exposed would have me off the planet just as soon as possible.
What exactly does a short-seller like you do?
When you short something, whether it’s stocks, bonds, currencies or commodities, you’re basically making a financial bet that that asset is going to decline in price. In a nutshell, you borrow a set of securities and you sell it in the market and hope you can buy it back later at a lower price. That sounds simple but it’s very risky because things can get carried away and prices can go higher than you think. When you buy something you can only lose the money you have invested in it. But when you short something and it goes out of control your losses can be severe. That’s why I always say don’t try this at home. Leave it to the professionals.
How does a short-sell work?
Let’s say I’m a cattle farmer and I think the price of cows is way too high. As a short-seller, I’m not only going to sell all my own cows in the market. I will go to my neighbors and ask if I can borrow their cows too and pay them back in cows when they need them. So I buy everyone’s cows and sell them at $500 apiece. As the price of cows goes down to $200 I buy the cows back in the market, return the cows to everybody I borrowed them from and make a profit of $300 apiece. But if the price goes up to $800 and I need to cover my positions I have to buy the cows back and lose $300 apiece.
That sounds fair. But some investors complain that short-sellers try to push down prices to make a profit. In fact, during the financial crisis the authorities even had to issue a ban on shorting banking stocks.
The short-selling ban was one of the dumbest and worst things ever implemented. In retrospect, everybody said it was a huge mistake. That was just sideways thinking by people who have things to hide. It’s something third world nations do. When they issued the ban on short-selling during the crisis the hedges of many investors converted. Also (ALSN 129.4 1.89%), it didn’t let people set up for trades and thereby kept potential buyers out of the market when it was time to buy.
Then why are short-sellers not more popular on Wall Street?
In the United States you have freedom of speech as long as you’re bullish and you don’t say negative things about much. People may not like me and some people may actually hate me. But they don’t really know me because I’m a lovable guy. It’s not like I’m calling someone’s wife ugly. I’m a believer in free markets, and that means you should allow buyers and sellers. You need price discovery and you need action and reaction to make markets work. People like me provide information in the market and that’s needed to warn investors of impending problems. So regulators should welcome short-sellers because we bring financial crimes and wrongdoings to their attention. We keep markets honest because we expose hoaxers and frauds for what they are. That’s why the role of short-sellers in the market is vital, especially for individual investors.
What does it take to be a good short-seller?
It’s not for everyone because it’s very volatile. The highs are really high the lows are really low. So to me it’s a trait you’re either born with or not. It’s like having a skeptical or deductive gene. You don’t go to Stanford, Harvard or Yale and they teach you how to be a short-seller. It’s a lot easier to make money by just going with the flow because stocks have a bias to go up. As a short-seller, you have the money against you and have the rules against you. Everyone’s trying to put an ax into your forehead. Also, having some good lawyers is essential. To me, you’re not anything as a short-seller unless you’ve been sued a couple of times. I pay lawyers about as much per year as promoters pay publicists.
So what do you like so much about your job?
It’s a challenge and it brings out the best in you. It’s like coaching football: when you win the Super Bowl the high is so high that you want to do it again and again and again. But then you realize how hard it is. I’ve had a lot of highs and I’ve had a lot of lows. One of my greatest satisfactions was my battle against Lernout & Hauspie, a Belgium-based speech recognition technology company. It was a complete fraud but I was under enormous pressure because the stock was so hyped and Microsoft (MSFT 68.665 -0.02%) and Intel (INTC 36.105 0.68%) were the two largest shareholders. There was even some Russian mob guy who threatened to kill me. But when the company went bankrupt in 2001 it turned out to be the largest fraud in the history of Europe at that time.
For years stocks basically just have gone up. How does that impact your profession?
Over time, the short-selling community has been decimated. Good short-sellers have become an endangered species. The amount of dollars in the world that is dedicated to buy stocks and to bet that they go up probably swamps the amount of dollars that is dedicated to shorting stocks by 15 million to 1. In the United States which is the largest market there is only about $5 billion of dedicated short money and probably about 80% of that money is divided between only three firms.
This bull market is now going on for more than eight years and valuations seem quite rich. Is this a good time to put on some short-bets?
I really don’t care so much about the stock market in general because I assume that stocks are going up every single day. That’s why I have to assume that I’m absolutely getting no help from the market. So I focus on the crappiest companies I can find: companies that are so poorly run and led by such hoaxers that if they go out of business tomorrow nobody will miss them. That’s where I take my chances.
Historically, at the end of every bull market fraud is being exposed. During the dotcom bubble you had infrastructure companies like Enron and Worldcom and during the housing boom you had subprime mortgage lenders like Countrywide Financial. What’s it going to be this time?
It’s a fascinating time. People don’t seem to be concerned about much, I hope everybody is happy. I don’t exactly know what will happen when the next bubble bursts. But it’s going to be around leverage and it’s going to have to do with private equity and with all these companies that have been drunk on stock buybacks. They are bound to the community of activist investors who coax companies into leveraging up and buying back their worthless stock. That’s going to come back and haunt people. But it’s kind of what I said before: I go more name by name and I am very focused on my day to day business.
A poster child of the buyback frenzy is IBM (IBM 152.57 0.36%). Is this a good stock to short?
This whole stock buyback and financial engineering concept just hasn’t worked for IBM. They just wasted a lot of shareholder money. But I’m not short IBM and I’ve never been short IBM. It’s one of those companies that would really be missed when they go out of business. That’s why I don’t play with most stocks in the Dow Jones (Dow Jones 21000.34 0.3%) and I don’t really play with most stocks in the S&P 500 (SP500 2402.95 0.19%). I like these crappy, poorly run outfits that usually never get big enough to get into the S&P 500.
How do you find such companies?
That’s sort of the secret sauce. One of my principles is to bet the jockey, not the horse. That means I try to bet against people who are incompetent and have a bad track record. They say things that don’t check out, employee turnover is high and former employees and customers tell very troublesome stories. That doesn’t necessarily mean it’s a great short. But when you see things like that it’s a good place to dig.
And what happens next?
I wait until there’s a flaw because problems tend to find other problems. I’ve seen a lot of this stuff come and go and I have a decent memory. I remember a lot of the garbage that has been going on in the past and history tends to repeat itself. So I look for that. It’s hard enough to run a business successfully when things are going well. But if there is financial engineering and funny stuff behind the scenes it gets very difficult and very hard to fix. So when these companies get into a problem, it’s usually not going to go away. And most people who are running such companies are not very good managers.
So you’re basically hiding in the bushes lurking around your prey?
I’m not hunting a jaguar that’s sitting in the tree because there are not a lot of easy ways to rustle it out of the tree. A lot of bad things can happen: The jaguar can attack me and I can fall down and get hurt. But if someone shoots the Jaguar out of the tree and the thing hits the ground and is injured I will go after it. Then I have a chance because it’s obvious that something is wrong with a company. I can fight it on the ground and carve it up, piece by piece. Right now, jaguars in the tree are names like Tesla, Netflix (NFLX 157.5454 -0.26%) or Amazon (AMZN 978.21 0.69%) where the markets are very high and very frothy. People are very bullish and everybody tends to own the same kind of names. I’m not saying I won’t be short any of these names at any point in time. But I won’t be short until someone shoots the jaguar out of the tree.
Who are the Jaguars on the ground right now?
Valeant Pharmaceuticals, for instance. I watched the stock go from $30 to $250 and I had no interest until something changed which was the Philidor revelation. That was the moment when someone shot the jaguar out of the tree and I jumped in. That’s my style. That’s how I do it. Once these companies get sick, their business model breaks given their leverage. So right now, Valeant is probably a better short at $14 per share than it was at $50, $100 or $250.
What about other shorts in your portfolio?
I go after companies which try to rip people off like Signet Jewelers, Stamps.com, Jackpotjoy in the UK or Concordia which is a complete joke. My latest short-bet is the Canadian oil and gas service provider Badger Daylighting. All these companies have significant issues. They are so poorly run and led by these hoaxers that I just take my chances there.
Do you also short stocks in Switzerland?
Once I was short the Swiss dental implant company Nobel Biocare (NOBN 17 0%). But that was the only shot I ever took on in Switzerland. They are very serious in Switzerland and the same is true for Germany. So I wouldn’t short any stocks there. Every now and then I short a couple of Spanish stocks because they are very confused there. They are also very confused in Sweden. But mainly I just stick to North America. To me, the best place to short stocks right now is Canada. They are completely and utterly inside out and given the leverage in that system some of these Canadian companies are absolutely fantastic shorts.
What’s going wrong in Canada?
The Canadian housing market is essentially the US housing market during the second half of the last decade but on steroids and LSD. People are leveraged to a scope I’ve never seen. In Toronto and Vancouver, which are the most moneymaking areas, the average income of a family is only about 80,000 to 100,000 Canadian dollars. But house prices are 8 to 10 times that. People live way beyond their means and in order to keep up they are borrowing more and more and more. The problem is that the people who are lending you money expect to be paid back. So when things change they are going to change drastically and people are not going to know what hit them. It’s going to be horrific.
How did this bubble grow so gigantic?
The Canadian housing market is a money laundering-induced market. They have sought Chinese money to keep the housing market propped up. But it won’t last. Especially Vancouver is a place for the criminal element to come into Canada and hide money. You walk around places at busy hours and there’s no one there. People own on multiple units and they’re just taking money from totalitarian areas and putting it into real estate, pushing up prices and crowding out people who really need to live there. The same is true for Toronto. It’s the financial capital of a banana republic. That’s what’s going on in Canada and they really need to start paying attention. They admit that they have a housing bubble and that they need to be doing something about it. But all they do is talk.
How do you short the Canadian housing market?
I think the five big Canadian banks are okay. But everything around the periphery is going to collapse. The regulators have been sleeping at the switch. To me, the struggling mortgage lender Home Capital Group is like the vulture in the Canadian housing coal mine. It’s Ground Zero for everything that’s wrong: you have mortgage origination fraud and you have laundered money. I have been talking about it in the media for two and a half years and I have exposed them for what they are. But regrettably, everybody is of the point of view to shoot the messenger and not listen to the message. What started off as a company which was telling stories and missing numbers in a booming housing market turned into mortgage origination fraud, then turned into disclosure fraud and will probably turn into insider trading. It will turn out that the numbers really aren’t the numbers.
And what about Equitable, Canada’s other large home lender?
Equitable is as sick as Home Capital. Now, the government seems to help out to try to stabilize the company. But that won’t work. It’s only going to delay the end result. They’re trying to say Equitable is fine and not Home Capital. But in a lot of ways Equitable has the same problems as Home Capital and they have their own specific issues. So I feel good about the work I’ve done. I feel really good about exposing this fraud and I think I will save Canada billions and billions of mortgage fraud when this thing is all set and done.