For bear stock pickers, 2023 is full of rich pickings

Wirecard AG

16/12/2022 07:00

By Nell Mackenzie
       LONDON, Dec 16 (Reuters) - Well-known activist
short-selling hedge funds expect to find more companies squeezed
by tough economic conditions in 2023, potentially increasing
instances where balance-sheet sinkholes are hidden. 
    Some $321 billion worth of U.S. and European
speculative-grade debt is due for refinancing over the next
12-14 months. Defaults may double in 2023, if interest rates and
corporate borrowing costs rise further, S&P Global Ratings
reckons.            
    Activist short sellers cross over into forensic accounting
when they go beyond reading balance-sheet statements and scour
footnotes and subsidiary findings to uncover if every line item
mentioned is true and cash flows match.
    Hedge fund Muddy Waters on Wednesday said it was shorting
Vivion Investments, suspecting the real estate investment firm's
portfolios were overvalued. The company responded with a
statement on its website on Wednesday saying Muddy Waters'
report contained numerous factual inaccuracies and said it would
respond in further detail next week. 
    Here are what some prominent short sellers say about how
they use forensic accounting, lessons they have learned and what
they expect in 2023.  
    1/ MUDDY WATERS
    *Size: $245m AUM 
    *Famous positions: NMC Healthcare, Burford Capital  BURF.L ,
Vivion 
    *Top tip: Do the numbers add up?
    Since the 2007-2008 global financial crisis, companies have
pushed aggressive accounting to its limits, said Muddy Waters
CEO Carson Block. Most of the companies he investigates have not
done anything illegal, but have exaggerated their value. 
    "Things are just out of control. People are milking the
system," he said, adding that he expects even more aggressive
accounting and fraud in 2023.
    "There's a lot of low coupon debt to be refinanced," Block
said. He was referring to companies that borrowed at low
interest rates over the last 10 years, but now face higher
coupons on repayments as rates rise.    
    Block said that low borrowing costs had encouraged fraud
because any increase in earnings, real or exaggerated, would
have a large effect on the company valuation, its stock price
and the amount of financing available. 
    "If you were a stock scammer with a $50 million fraud ten
years ago, it would be a huge number. Today the typical fraud is
more like $100 million," Block said. 
    Clues that led to Muddy Waters' most recent short included
an in-person visit to the property sites of real estate
investment company, Vivion, to find out if their rental
properties were as valuable as the company said. One they found 
was "vacant and derelict," Muddy Waters' report about the
company said. Vivion said it would respond with a further
statement and that this picture was not accurate.
    2/ ANALYST ALPHA GENERATION  
    *Service: Subscription-based research
    *Famous research tip: Wirecard 
    *Top tip: It pays to pay a visit
    Mark Hiley, the director and founder of the Analyst, is not
a short seller, but his company sells ideas to short sellers who
subscribe to his research. 
    He was among a handful of outspoken critics pointing to
wrongdoing at payments firm Wirecard in what proved to be one of
Europe's biggest fraud scandals. 
    His firm recently did a research project on the 2023 picture
for European corporations and Hiley concluded: "If you double
interest costs, a lot of companies will spend their entire
earnings before tax just on that."
    In coming years, British accountants could be required,
under recent government proposals, to look for fraud at
companies they audit. 
    One result could be detailed disclaimers where auditors try
to protect themselves by disclosing what they have not checked
out. This would be the perfect place to start looking for signs
of potential fraud, Hiley said.
    Sometimes, going through paperwork is not enough. 
    Hiley said he had already dug through paperwork to see if
the assets on the balance sheet of a German logistics company he
was investigating truly existed. After watching a factory tour
on social media, he sent someone to visit the site. 
    "It was basically a shed in a forest. On YouTube, it had
looked like a whiz-bang logistics facility with 500 trucks
parked outside," he said. 
    3/ SHADOWFALL
    *Size: $90m 
    *Famous positions: Wirecard, Civitas, Boohoo  BOOH.L  
    *Top tip: A short matters only if the shareholders care
    The secret to uncovering the perfect short is that
shareholders need to care about your findings, said Matthew
Earl, the hedge fund manager behind Shadowfall.  
    If investors think the company will ultimately do well, they
might overlook aggressive accounting, he added.
    In more serious cases of fraud, no one may believe the
findings at first. German authorities initially tried to
prosecute Earl over his short on Wirecard. Two years later, the
government apologised. "It was complete vindication," said Earl.
    
    Tighter monetary conditions and less readily available debt
means investors will likely scrutinise company cash generation
in 2023, Earl said.
    He added that most fraud was not premeditated but the result
of a decision that spiraled out of control.
    "There'll be an incentive by management of the company to
paper over cracks," Earl said.
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High risk debt to refinance    https://tmsnrt.rs/3Yr46DF
The US has the lion's share of risky debt to refinance in 2023
The US has the lion's share of risky debt to refinance in 2023  
 https://tmsnrt.rs/3Ptrj45
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 (Reporting by Nell Mackenzie in London
Editing by Dhara Ranasinghe and Matthew Lewis)
 ((Nell.Mackenzie@thomsonreuters.com;))