Macaskill on markets: Cassandra Inc is a long-term bet
Hedge fund manager Bill Ackman’s desperate attempt to push down the stock of nutritional supplement provider Herbalife provides the highest profile recent example of the challenges faced by short sellers.
|Bill Ackman is planning an IPO for later this year
Simply being right about flaws inherent in the valuation of a stock or debt instrument is not enough. The short seller has to persuade other market participants to join the raid, or wait for a broader market downturn, all while paying the cost of carry involved in a short trade.
This can extend the time frame for a successful bet too far into the future for many investors. Cassandra – an early doomsayer whose predictions were initially dismissed – was right to foresee the destruction of Troy, but the siege of the city took 10 years. Few modern investors would give a hedge fund manager 10 years for a trade to pay off.
The pension funds and other institutions that are playing an increasingly significant role in backing hedge funds seem bizarrely tolerant of a combination of erratic returns and high fees, though even they might draw the line at a big trade that lost money for a decade.
A good track record will buy a short seller some time, however.
Ackman’s Pershing Square hedge fund group has provided an annualized return of 21% since 2004 and its four main funds were up by roughly 25% in the first half of 2014, despite the current failure of the attempt to drive down the price of Herbalife.
Ackman is even planning an IPO for later this year to add permanent capital to his investor base, apparently calculating that any distaste for the histrionics he has deployed in his attack on Herbalife will be outweighed by appetite for a piece of the Pershing pie.
Ackman’s most recent assault on Herbalife drew headlines as he displayed a level of hucksterism that was impressive even by his own high standards. After appearing on business news channel CNBC on July 21 to promise a presentation that would “expose incredible fraud” at Herbalife, Ackman the next day made a three hour pitch backed by over 200 pages of slides that was devoid of any significant new information about a firm that he has repeatedly accused of being a pyramid scheme. Perhaps sensing that he was losing his audience, Ackman ramped up the rhetoric by comparing Herbalife and its managers to drug dealers and Nazis, and at one point wept as he contemplated the American Dream and the supposed threat to that dream posed by Herbalife.
The short-term effect of Ackman’s presentation was disastrous. Herbalife started to rally as soon as he began to speak and rose by 25% in a day. The stock unwound most of this jump later in July when the company announced earnings that were well below consensus estimates, however.
Ackman in August told investors that he was prepared to extend the maturity of the options he bought to profit from a fall in the price of Herbalife stock, most of which mature next year.
If that was not a bluff, this move indicates that Ackman still feels he can afford to pay the cost of carry of the short position while he holds out for his desired end result: a condemnation of Herbalife’s sales practices by US federal authorities that would cause existing investors to flee the stock.
The strong performance of some of Ackman’s long positions – such as a holding in Burger King stock that was boosted by its move to buy Canadian coffee chain Tim Horton – has effectively given him time to continue what is already a two-year quest to force down Herbalife’s stock.
It is not clear how Burger King’s bid, which is partly motivated by a plan to shift its corporate headquarters to Canada to cut its US tax bill, fits in with Ackman’s notion of the American Dream. But the important thing is clearly that the hedge fund manager is able to make sure that his short position in Herbalife turns out to be a good long-term bet.