Tuesday, March 28, 2023

Chanos sees short-selling resurgence in new “golden age” of fraud

  • Famed short-seller is on European tour to highlight recently launched Ucits fund
  • He comments on outlook for strategy, Adani case and market environment

“When people ask me where are you looking for fraud, my stock answer is: it’s right in front of you,” says Jim Chanos.

“It’s the way in which companies are presenting money-losing enterprises as profitable. That’s where investors have to be really careful.”

Chanos knows this better than most. The famed American short-seller exposed the Enron fraud, bet against Wirecard and has spent almost four decades combing through company footnotes.

Speaking to AFI in a Mayfair boardroom, Chanos admits it has been a lean era for short-sellers since the financial crisis, with a long bull market and zero-rate environment supporting even the weakest companies.

That has all changed now, with market volatility back and rates rising. Short-sellers have been in the headlines after the report on Adani by Hindenburg Research wiped billions off the Indian conglomerate’s share price.

Chanos does not pursue the same “activist short” approach but supports Hindenburg’s right to publish research.

“I read Hindenburg’s piece when it came out. I thought the work was pretty thorough,” he says.

He is in Europe to market a new Ucits offering, Chanos & Co Equity Long/Short, a daily-liquidity Ucits fund managed by Green Ash and sub-advised by Chanos & Co.

It generates alpha on the short side, risk-managed with passive long positions — well suited, it would seem, for the new golden age for fraud identified by Chanos.

“Whether it was what we saw in the crypto space last year, where fraud was endemic, or the use and abuse of pro forma metrics, which I really think the regulators have dropped the ball on.

“How aggressively corporations are in presenting their metrics to investors — adding back various expenses, routinely, to make the results appear better than they are.”
General Electric just released earnings with 16 pages of adjustments. “That’s incredible,” he says.

“When you have companies with share-based earnings equal to their revenues, it’s reductio ad absurdum… it’s kind of insane.”

Having previously run billions, Chanos & Co, founded as Kynikos Associates in 1985, now manages less than $500m. “We are hoping to grow that back up. This Ucits programme is part of that,” says Chanos.

Heading a team of 40 staff, he splits his time between its New York headquarters and Miami.

“2021 was the most speculative year in the market I have seen in my 40-year career,” he says. From the meme stock craze to the SPACs boom and NFTs, bubbles were everywhere.

“The combination of all of it, coupled with some huge IPOs and the belief the total addressable market was a legitimate way to value a company, was really a witch’s brew, in terms of over-valuation.

“I called it dot-com on steroids and I firmly believe that. The market caps of the companies we were looking at were almost 10x, similar to what we saw in 2000. From a fundamental short perspective there is going to be a very interesting set of companies going forward. A lot of them don’t have realistic business models.”

He believes the scene is now set for a great period for shorts, similar to the wake of dot-com.

“Fundamental short-selling had a great period after 2000, for the better part of ten years, because of the companies that came public in 1999 and 2000. No matter where the market goes, you are going to see a large cohort of businesses that are challenged from a business model point of view.”

The January rally in markets was not helpful but not a surprise to Chanos. “We have seen these very sharp rallies since the first half of 2021 — the speculative peak,” he says.

“I would point out, from 2000 to 2002 there were eight to ten such rallies. Every few months there was another jarring rally, particularly in the speculative stocks, when people said ‘we are back to the races’. I’m just not sure that is going to be the case. But I do think you are going to see a lot of volatility.”

The US retail investor is “still very active” particularly in the weekly options market, which Chanos calls “pretty much akin to gambling.”

It has led to odd situations. He highlights an unnamed short on a company with a $2bn-plus market cap but bonds trading at 25 cents on the dollar.

“A finance professor would tell you that shouldn’t exist,” he says. “I don’t understand what retail is doing. It is the biggest slap in the face I have seen in the efficient market hypothesis in years.

“It is akin to a casino late at night where the investor came in with a fair amount of money, is down 50% but still has lots of chips. Maybe three or four cocktails in them and they will be convinced to get it all back.”

Chanos & Co has been public on a few areas of shorts, including commercial real estate. “I think the office sector continues to be troubled, particularly in big cities. New York has [only] just got back to 50% occupancy.

“We are even more bearish on the data centre space. Investors are valuing them at very high multiples and there is no free cashflow in the business. Valuing them on cap rates of 4% or 5% is nothing short of absurd.”

Speaking to AFI as part of his European tour, Chanos highlights Wirecard as one of the few major success stories which validated the strategy since the financial crisis.

“What was remarkable was that the stock still levitated for another nine months, until the company admitted the fraud itself.”

It was symptomatic of a financial climate which made life hard for shorts. “It has been a difficult environment because everyone was getting capital and time-frames were extended for money-losing companies to become profitable.

“Valuation was based on forecasts ten and 20 years out, discounted back at very low interest rates. You could almost argue anything. With rates back up to more normalised levels of 5, 6, 7%, it is a different ball game.”