The year 2013 will be remembered as a very painful one for anyone who was short just about anything. Dedicated short funds got clobbered while even long/short funds found that their massive losses on soaring short positions greatly curtailed what should have been a stellar year on the long side.
But now the shorts appear to be coming back with a vengeance. And recent trades show that the shorts have been doing well in publicly exposing troubled companies where they suspect substantial overvaluation, evidence of excess promotion and, in some cases, fraud.
Many institutions are now realizing that in a very toppy market, finding that next long trade that will go up by 50% or more is now extremely difficult. By contrast, finding overvalued and troubled companies which should quickly fall by 50% is now quite easy. They are everywhere.
As a result, many institutions are getting much more vocal about their favorites short trades while research efforts are being increasingly devoted to short ideas.
My inbox is now brimming with some very impressive short ideas which get submitted to me from all over. Many of these appear quite compelling, so I expect I will be very busy publishing as soon as the holidays are done.
But for now, I take a look at some of the more compelling short calls that are still in play, including Organovo Holdings (ONVO), Unilife (UNIS), Renewable Energy Group (REGI) and Opko Health (OPK).
Organovo
A $700 million market cap reverse merger, Organovo acquired its IP for just tens of thousands of dollars a few years ago and spends just $1 million per quarter on R&D. Even its own management expects no commercial revenue until December 2014 (at best). At that time, revenues may eventually ramp to "tens of millions of dollars", which would potentially justify a $3.00 share price, but certainly not more. Yet actual timing for this eventual ramp is unclear.
In the last quarter, grant and collaboration revenue was a mere $23,000. Not surprisingly, management has been selling millions of dollars worth of stock in just the past few months while filing to sell millions of new shares by the company as well. Meanwhile the company is held 93% by retail investors who appear convinced that they will become obscenely wealthy when this company eventually fulfills its futuristic destiny of "3D bio-printing" fully useable human organs. I have been active in Organovo for most of the year and I enjoy the fact that I have been one of just a few people to write about the short thesis this year. Back in November, the stock traded to just shy of $14.00 (exceeding well over $1 billion in market cap), but following my last article the shares fell by around 40% to around $8.00. They have currently bounced slightly and trade for $8-9. I am still short.
Unilife
In contrast to Organovo, it seems that everyone who has ever shorted a stock has recently shorted Unilife. They have also invariably felt compelled to publicly tell the world why this is such a compelling short. When this many parties are short a stock, naïve investors may be tempted to play it for a short squeeze. But given the size and commitment of the institutions involved, they likely have ample staying power to simply short more if Unilife rises some. The near term catalyst for Unilife is a desperately needed equity offering as the company runs out of cash. This may see the share price quickly drop by around 20-30%. But the real catalyst will be the ultimate resolution of litigation alleging massive fraud against investors. This is the black swan event that has the potential to send Unilife to zero on short notice. A copy of the current legal filings in these fraud suits can be found at my website moxreports.com. Anyone who is long or short Unilife should certainly feel obligated to at least read these legal filings.
Investors who are long Unilife should take pause to consider whether or not they should care about the institutions who are vocally short Unilife:
Why should investors care what Whitney Tilson says?
Tilson has been on a roll lately with his public short trades. Names like Questcor (QCOR), Lumber Liquidators (LL), K12 Inc (LRN) and InterOil (IOC) have often shown moderate drops following his announcement of a short position, but have then gone on to drop by 30-60% in subsequent weeks. According to headlines, Tilson referred to Unilife as "an obvious fraud". This is the oldest trick in the book for short sellers. If a short is confident that a company is committing fraud, he makes a loud public statement of this. He is hoping and praying that the company will sue him such that he can get legal discovery in court. This is why troubled companies almost never sue their accusers. In any event, investors should now be quite concerned that Unilife does not feel any need to take action against (or even respond to) parties who make such aggressive public statements. But of course, just because Whitney Tilson is short Unilife does not mean it will go down by 50-100%.
Why should investors care what "The Street Sweeper" says?
According to its website, "The Street Sweeper" has published nine short reports in 2013. Only one of these stocks has gone up since the report. (Ticker SGMO is up by around 12%). Other stocks have fallen by 20-95% following Street Sweeper reports. Unilife investors may also wish to take note of the fact that The Street Sweeper published reports on both Revolution Lighting (RVLT) and Coronado Biosciences (CNDO). These risky reverse mergers were highlighted as great long picks by Unilife promoters Tech Guru and The Focused Stock Trader. The reports from The Street Sweeper did not cause immediate drops in these stocks. Instead, the subsequent events, which were described by the Street Sweeper, caused these stocks to fall by 30-80% in subsequent weeks. But of course, as with Tilson above, just because Street Sweeper is short Unilife does not mean it will go down by 50-100%.
Why should investors care what Kerrisdale Capital says?
Kerrisdale Capital's website simply states that "We make value-oriented investments in public securities". But what many investors may not realize is that Kerrisdale made the bulk of its fortune almost entirely by shorting frauds and presumably playing many of them to near zero. I first heard of Kerrisdale a few years ago following their scathing short report on China Education Alliance (formerly CEU). The report was so aggressive that I felt it simply must have been overstated. Further research on my part revealed that this "hedge fund", Kerrisdale, was based in New York and did not demonstrate any China specific credentials. The credentials of the "investigators" that it had employed in China were also not clear. Kerrisdale's assets under management of just a few million dollars at the time hardly qualified it to be called a "hedge fund" in my view. I flew to Harbin, China for a week to evaluate a potential long investment in the stock which had been beaten down following Kerrisdale's report. I found that Kerrisdale was wrong. Kerrisdale had stated that CEU was "mostly a hoax". Instead, my work on the ground revealed that CEU was in fact "entirely a hoax". It would have been laughable had it not been so criminal. Investors need to remember that at the time, CEU had been listed on the New York Stock exchange and had at times been valued at over $200 million. They continuously made the rounds and had been featured at all of the popular investment conferences of the time. They had been perceived as an entirely legitimate company until they were exposed by Kerrisdale. The company was subsequently delisted from the NYSE (even after its auditor had confirmed its "enhanced cash verification" procedures at CEU).
Kerrisdale went on to become a prominent short seller of fraudulent companies and based on that success grew from a tiny $2 million fund to reportedly over $100 million in around 2 years. Although Kerrisdale is not a dedicated short fund, they are regarded as one fund that originally rose to prominence purely off the back of their expertise in shorting fraudulent companies. So now we have Tilson, Street Sweeper and Kerrisdale all convinced of an imminent plunge in this controversial stock. But of course none of this guarantees that they are all right.
Renewable Energy Group
This is perhaps my favorite among under-followed shorts. There is so much nonsense going on here that I expect this stock will drop by at least 50% during the month of January. The only risk is that the trade may get crowded as the stock falls to around $7.00, such that further declines may end up being a bit slower. In any event, the trade is a low risk short without any meaningful upside catalyst in the foreseeable future.
Prescience Investment Group was the first one out of the gates to highlight the short thesis on this stock. I am now joining the battle cry on this short trade, but based on new and very different issues. As with Unilife, I expect that this will quickly become a favorite short trade among investors.
Prescience highlighted the fact that REG is heavily dependent upon tax credits which expire on December 31st, 2013. In years past, without such credits, revenue sat at around $100-200 million. At that time, REG (as expected) lost money and burned cash. But the extension of these generous credits allowed REG to swell revenue to over $1 billion. The firm became profitable and cash flow positive. It should be fairly transparent what will happen as soon as these credits expire in just a few more trading days. REG will return to a troubled state of losing money and burning cash.
Some who are long this stock are clinging to hope that Congress will simply change its mind and renew the credits in 2015 or 2016. After a year or two of losses and cash burn, they hope the government handouts will continue to provide support to REG. This is extremely unlikely. The past extensions were simply stapled on to an unrelated fiscal cliff bill as "pork" by affected states. The urgency of the fiscal cliff made this easy to slip in. Unfortunately the tax credits are largely uneconomic and most people (including Congress) now understand that the full "carbon footprint" of producing, converting and transporting biofuels greatly reduces their relative benefit. The size of that relative benefit had previously been considered to be much larger and made it easier for members of Congress to overlook the poor economics of the tax credit. It is now no longer easy for them to overlook such uneconomic and wasteful government spending.
More recently, significant attention to fraud and diversion by those in the biofuels industry also makes it much harder for Congress to allow another tax extension to slip into any unrelated bills. As noted in the Daily Caller just a few days ago, "Fraud! EPA finds 33.5 million more fake biodiesel credits". A host of similar articles can be found with a simple Google search. The point from all of this is that we should now expect much greater resistance from members of Congress when individual senators try to slip in these extensions as part of "pork" amendments into unrelated bills.
Prescience also points out that insiders have been aggressively selling ahead of this expiration, with the two largest shareholders unloading $50 million in stock in just the past few months, and (of course) ahead of the tax credit expiration.
I was slow to get involved in this trade due to other projects. What finally caught my attention was the company's recent acquisition of Syntroleum (SYNM) last week, which REG rushed to complete before the tax credit expired (and while their share price was still in the double digits).
To me, it is this acquisition which seals the deal on REG as a short trade. Investors in REG may wish to strongly reconsider their enthusiasm for the acquisition of Syntroleum for over $40 million.
Earlier in 2013, Syntroleum had traded down to just 35 cents, but it conducted a 1:10 reverse split in order to avoid a delisting.
This is not surprising given that the company's only plant has been completely shuttered and without any production whatsoever since October 2012.
Syntroleum operates via a joint venture with Tyson Foods via a JV called Dynamic Fuels.
Syntroleum filings reveal the following:
Primarily as a result of the extended period the Plant has been in standby mode, Dynamic Fuels determined that the carrying amount of the Plant may not be recoverable.
Depending on whether or not the plant is restarted, the company will reassess potential for recoverability and any potential impairment.
Syntroleum is actually in the business "renewable diesel" not "biodiesel." REG is only involved in actual "biodiesel". Investors need to understand that these two products comprise entirely and radically different technologies which are in no way compatible. There are no synergies in the technology whatsoever.
The facilities of REG and Syntroleum are also on opposite sides of the country, with Syntroleum's only plant (the shuttered one) being in Louisiana. So there are no synergies with respect to their geographic locations either.
So why did REG suddenly rush to pay a massive premium for an acquisition of a no-revenue, non-producing nano-cap which had been facing delisting? It is simple. REG likely knows (as its largest shareholders do) that the share price is likely to begin a steady descent in January. With the share price above $10 at present, the stock serves as a valuable acquisition currency and it needed to be used before the share price declines. When the share price falls to $5.00 or below, such an acquisition becomes entirely too dilutive.
Both that major shareholders and REG as a company are eager to trade shares of REGI for something which may retain some value after December 31st. The shareholders sold, trading their shares for cash. REG issued more shares in exchange for an acquisition, hoping that it will retain at least more value than a falling share price.
It may be the case that in future years, "renewable diesel" becomes a far more viable product that simple "biodiesel". This is the lottery ticket that REG decided to purchase while it still had the buying power of a high share price. It is clear that when things become bad, management teams (at all companies, not just REG) often feel the pressure to "do something … do anything !". And this is how I view the Syntroleum acquisition.
Even though this short trade is patently obvious, the stock has yet to exhibit a meaningful decline. We have seen this repeatedly in 2013. Many investors simply wait until AFTER a negative catalyst emerges and drives the stock lower, rather than selling in advance of a negative catalyst. They then sell at a substantial loss which could have easily been avoided. The $50 million in recent sales (in advance of the tax credit expiration) by REG's major shareholders suggest that they are a bit more pragmatic than less informed 3rd party shareholders.
The last short report from Prescience affiliates was Fleetmatics Group PLC (FLTX). By the time I finished reading this report in September, the stock was already down by around 25% that day so I decided not to chase it further. But Fleetmatics is headquartered in Ireland, so before the US markets opened on day two I was able to speak with company representatives in Ireland and I learned that they had no coherent response to the scathing allegations being leveled at them. Nothing.
As a result, I shorted on the early morning bounce on day two. When the market's expectation of a response was sorely disappointed, the stock resumed its decline, quickly falling another 20%. Although I missed the best part of this trade, it was still quite reasonable.
Opko Health
Last year we were all treated to the entertaining spectacle of Ackman vs. Ichan in the Herbalife (HLF) long-short debate. It was so much fun to watch that Bronte Capital's John Hempton dubbed it "hedge fund porn".
This year we are being treated to a sequel where Lakewood Capital is squaring off against the Street Sweeper in a long-short debate on Opko.
Lakewood originally presented this thesis on November 21st at the Robin Hood Conference in a presentation entitled "Opko Health: The Placebo Effect".
During 2013, I published two articles on Opko Health. Both of these disclosed my short position and both of them coincided with a double digit percentage drop in the share price of multibillion dollar Opko. In one case, Opko responded to my concerns in a public press release.
The South Florida Business Journal noted that "Opko Health issues statement after shares drop 10% in heavy trading".
At 45 pages in length, Lakewood's piece is the most thorough analysis of Opko's history and its product portfolio that I have seen so far. The grim view expressed by Lakewood did not really spill over into the mainstream until December 11th, when $5 billion Opko began a plunge of as much as 30%.
Lakewood outlines its view very clearly and presents a very strong case for why investors should sell Opko. However where Lakewood fails is that it fails to explain why investors should sell Opko … RIGHT NOW. In other words, despite the significant concerns raised on valuation and history, Lakewood does not present a clear and identifiable catalyst for a near term decline in Opko. One painful lesson that I have been forced to absorb during 2013 is that overvalued companies have a way of staying overvalued (or even becoming more overvalued) for extended periods of time before they correct.
When I presented my two short theses earlier this year, I also took the view that Opko was overvalued. I also raised concerns about overly optimistic outlooks for Opko products such as 4KScore without adequate substantiation for those bullish views. However, my reason for being short the stock was more based on what I felt was a near term catalyst. In each case I felt that the onset of any meaningful amount of insider selling would cause a quick reversal in sentiment by Opko longs, who are most retail investors.
It has been many months and Opko had nearly doubled, but so far my predictions have been disappointed. I never expected Dr. Frost to sell any stock. The selling I expected would have come from the newly minted insiders who sold their companies to Opko in exchange for stock. These entrepreneurs received tens of millions of dollars in Opko stock and then watched the stock go on to double or triple. It seemed inconceivable that they would not sell as soon as any lockups expired. Yet they haven't.
As my catalyst failed to materialize, Opko's product portfolio comes closer and closer to larger revenue catalysts, which increases the risk of being short Opko.
So now there are multiple competing catalysts as follows:
Downside catalyst: Insiders did not sell at the time of their lockup expirations or 144 eligibility. But perhaps they are instead simply waiting for a new calendar year and will sell in early 2014, still at prices neat all time highs. Investors will sell en masse upon the first reported insider sale. Or of course, maybe this won't happen.
Upside catalyst: Large scale revenues could begin to materialize from products such as 4K Score and which may reduce the current valuation discrepancy. If more than one of Opko's "shots on goal" begin to pay off at the same time, there could be significant further upside to Opko's stock. Or of course, maybe this won't happen.
Downside catalyst: Revenues may materialize but they may be far less than expected. This would give credence to the Lakewood thesis that revenue expectations are now confirmed as being unattainable. Stock will sell off. Or of course, maybe this won't happen.
Conclusion on Opko
Many on Wall Street refuse to ever utter the words "I don't know". They feel that they must have an opinion on everything. In the case of Opko, I have no problem saying that at the current time, "I don't know" which way the stock will head.
I will continue to monitor for the emergence of the catalysts above. I also continue to conduct substantial independent research on components within Opko's product portfolio using various tools at my disposal across multiple countries. I also continue to receive ample amounts of analysis from various 3rd parties (both positive and negative). If I can get meaningful clarity, then I will trade accordingly.
Conclusion on Dr. Frost
Although I was previously a vocal short on Opko during 2013, readers should be able to see that I have never expressed any lack of respect for Dr. Frost himself. Over the years Dr. Frost made billions of dollars through successful investing and management within the healthcare space. He has delivered many more billions in shareholder value to the investors who were involved in his companies.
Even those who are short Opko or other Frost names should certainly acknowledge the inherent value that his involvement brings to the table. The "caché" of Frost allows Opko better access to new acquisitions, potentially at favorable prices. His involvement will also likely give him an edge in penetrating distribution channels with products within Opko's growing portfolio. Finally, there is the element that thwarted my two short theses in 2013. Confidence in Frost by insiders (new and existing) seems to reduce the likelihood of them selling their stakes in Frost related entities even following sharp rises in the share price. This keeps confidence (and share prices) in Frost entities at premium levels.
Additional Frost plays
At present I have no position in Opko, but I reserve the right to go long or short Opko at any time based on new findings. I continue to conduct my own research and I continue to receive much research from external sources. In the meantime, I have occasionally played some smaller Frost plays on the long side and done quite well.
Despite my vocal shorts about Opko during 2013, the many retail investors who follow Opko have not held a grudge against me and have kept things surprisingly civil. They regularly send me fairly detailed analysis of Dr. Frosts many other, smaller investment plays, which I probably would have not been aware of otherwise. Although the bullishness from these investors is often a bit excessive (i.e. "this is a guaranteed 30 bagger"), the opportunities presented are often very attractive on a risk reward basis (when kept in realistic perspective).
I was previously long on Castle Brands (ROX) and did reasonably well. In 2013, Castle was a quadruple as of November, hitting $100 million in market cap. As of December it is still a triple since January. I was also long on Biozone (OTCQB:BZNE) for a time, but I am currently on the sidelines as new developments there need to be digested. I am currently long Senesco Technologies (OTCQB:SNTI) which is one that I believe will go up 3-5x in 2014. Dr. Frost disclosed a 9.9% investment in just Senesco last week, which has not yet been noticed by many investors.
Earlier in this article, I made the point that some of the best shorts in the country have expressed complete conviction that Unilife is headed to zero. This universal conviction certainly does not guarantee that Unilife will go to zero. But I believe that it tilts the scale greatly towards a likely share price decline.
Likewise, many investors in Opko (and many other Frost names) seem convinced that the involvement of Dr. Frost somehow "guarantees" that his stocks will do well. Again, there is certainly no guarantee, but the involvement of Frost is certainly a positive, not a negative.
Afterward
I am currently in the process of authoring two books on reverse merger fraud in the U.S. and in China. My experience in Harbin investigating China Education Alliance currently occupies two full chapters, one on due diligence techniques and one on lessons learned. It was a bizarre experience, parts of which are laughable and parts which are tragic.
I have many, many other examples of reverse merger fraud gained from years of experience and observation. But I always welcome submissions from those who have their own observations, experiences and case studies which they may wish to share. I would be quite honored to hear from anyone who has been a victim or who has had experience in exposing such schemes. For those who wish to share anonymously, confidentiality is assured.
I have now looked at so many reverse merger frauds and stock promotions that I view it as largely a cookie cutter process with blatant similarities shared across the vast majority of them. I hope that by illustrating the patterns and techniques involved in these processes, I can provide a useful handbook to allow investors to avoid getting hoodwinked in these never-ending schemes.
Disclosure: I am short ONVO, UNIS, REGI. I wrote this article myself, and it expresses my own opinions. I am not receiving compensation for it. I have no business relationship with any company whose stock is mentioned in this article. I am short ONVO, UNIS, REGI. No current position in OPK. I am long SNTI. I reserve the right to add, reverse, hedge or eliminate any long or short positions mentioned in this article at any time and may or may not provide further updates or analysis on any of these situations or my positions in them going forward. In the past the author was an investment banker who provided financing services and advice to U.S. listed healthcare companies. The author has not engaged in any investment banking activities in over 5 years and has no historical business relationship with any companies mentioned in this article. None of the information contained within this article should be construed as investment advice. Investors should always consult their financial adviser before making investments.
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