The Perils of Short Selling: Citron Research Edition

MOBILEYE BUYOUT BY INTEL: CITRON REFUTED(?)

Today Mobileye (ticker: MBLY) announced that it was being acquired by Intel in an all-cash buyout at $63.54/share (see company PR here). One consistent and prominent bear on the stock has been Citron Research, now famous for its Valeant short call in October 2015 (see PDF here). Just a month before issuing its VRX call, Citron gave its thumbs-down verdict on Mobileye (see PDF here), stating the following:

There is NOTHING in the past or present financials, business performance or realistic future prospects of Mobileye that would get it within miles of justifying its current $12 billion market cap. They do not own a bar-the-competition patent portfolio on ADAS, nor do they have locked-in decades-long supply commitments. There are no barriers to entry for competitors other than legitimate R&D, and they do not have superior technology. They just got there first. Investing in this company is a "Hail-Mary bet” on a blue-sky future that just does not exist. This is not merely the opinion of Citron-- it is the actions of management who have spoken with their dollars -- loud and clear -- selling stock more aggressively than Citron has ever witnessed -- as documented in this report.

Well Intel disagrees and put its (shareholders') money where its mouth is--namely to the tune of $15,300,000,000. So Citron turned out to be horribly "wrong", at least in the sense that they lost their bet. Perhaps Intel will regret the acquisition down the line, but that won't help Citron. Thus we see one of the main perils of shorting: you can perhaps be right on the fundamentals (Citron has a good track record overall), yet a large company with billions of cash burning a hole in its pockets could simply disagree and the shorter will lose serious money when a takeover is announced. On the long side this cannot occur, unless management inexplicably sells a company out from under its shareholders at an obscenely low price (but even here the shareholders will at least get to vote on whether the deal goes through or not). On the short side there is no choice, except to eat the losses and move on to (hopefully) greener pastures.

Below is Citron's reaction to the deal, as per Marketwatch, along with our (admittedly snarky) interpretation of their remarks:

While we are scratching our heads at the economics of paying almost 30x 2017 revenue [TRANSLATION = We still think we were right, even though at this point we look stupid and we're losing money], the deal is done and we will move on [TRANSLATION = We have no other choice but to eat the losses and move on]. Who should be most amazed is management, who has sold hundreds of millions of dollars of stock at significantly lower prices during Mobileye's short lifetime as a public company [TRANSLATION = We are extremely PO'd at management for winning while we lose, which is the opposite of what should be happening, so we'll take this opportunity to bash them]....Neither Citron nor any analysts who covers Mobileye saw this coming [TRANSLATION = We we wrong...but so were other supposedly smart people, so that makes us feel better].

So, to sum up with a picture:

Hey, you win some and you lose some, which brings us to another of Citron's "no-brainer" short recommendations, Chemours...

CITRON'S TAKEDOWN OF CHEMOURS: THE EINHORN STRIKES BACK

In June of last year, Citron issued a negative report on Chemours Co (ticker: CC), boldly stating (among other things) the following about the company:

THIS STOCK IS A ZERO. After 15 years of publishing, Citron can confidently state that Chemours is the most morally and financially bankrupt company that we have ever witnessed.... Citron thinks the most likely scenario is that Chemours goes bankrupt within 18 months ... just long enough for the new Dow/DuPont to split into three companies, and create separate entities that will all fight for indemnification from this financial toxic dumpsite of liabilities. If there is any justice in this world, Chemours will go bankrupt before the eventual liabilities they have created fall into the Death Star. You don’t have to be financially sophisticated to see that Chemours, with $4 billion in debt, and a mere $20 million reserved for C8 liabilities is hanging on by a thread.

Well, at least Citron doesn't mince its words. Fast forward about two months and we see that David Einhorn of Greenlight Capital (himself famous for successfully shorting Lehman Brothers during the financial crisis) was having nothing of the Citron short thesis (per a Bloomberg story):

Bloomberg summed the situation up as follows:

David Einhorn’s Greenlight Capital said it took a stake in Chemours Co., the titanium-dioxide pigment maker spun off from DuPont Co., denouncing a short recommendation from Andrew Left’s Citron Research that said the company had been "designed to fail."

"We see an obvious flaw in this analysis," the hedge fund wrote in a second-quarter letter to investors dated Tuesday. Greenlight refuted Citron’s contention that liabilities, including 3,500 lawsuits from people living near a Teflon plant in Parkersburg, West Virginia, would bankrupt the company. Greenlight said it used a decline in the company’s shares caused by the short-seller’s report in June to add to its stake. "We enquired directly about the $5 billion estimate, and the author of the report acknowledged there was no math to justify the figure," Greenlight wrote in the letter, without naming Left directly.

The Citron report contended that medical monitoring, cleanup, damages and legal fees stemming from the use of a chemical to make non-stick coatings could cost Chemours and DuPont more than $5 billion. Outside experts pegged the liability at several hundred million dollars, the hedge fund wrote, leading it to believe Chemours’s "debt and legal liabilities are manageable." "I do not want to have a public fight with David," Left wrote in an e-mail, responding to a request for comment on the letter. He added that it is most important that victims in the cases receive proper compensation.

Well, suffice it to say that, at least so far, Einhorn is having the last(?) laugh at the expense of Citron. Again, to sum up with a picture::

So far it looks like Citron is down massively on its CC short (indeed, based on the timing of its report, it may have already lost 3X its original investment, whereas with a long position one cannot lose more than 100% of the money invested), assuming it hasn't covered yet or added to its short as the stock has risen. But, hey, maybe Citron was just "early"...

CONCLUSION

The point of this post is not necessarily to ridicule Citron, which has a good track record overall, but rather to point out how dangerous the practice of shorting stocks can be. A big dumb company can come along and buy out your "no-brainer" short at a 40% or 50% (or even 100%) premium to the prevailing market price. Or a smart and influential hedge fund manager such as an Einhorn can mercilessly exploit a supposed hole in your short thesis publicly, causing the stock to rise and you to have to choose between (A) admitting defeat and covering at a medium to large loss, even if you think your thesis is still correct, or (B) not admitting defeat and later sustaining a truly gigantic loss (which might even, due to margin calls, wipe you out completely). Sounds like a fun business model. Anyone still for shorting?