Gotham Research is considered an enigma on Wall Street – and this is how its founder, Daniel Yu, likes it.  When they first boomed onto the scene, really having been “discovered” within the last year, there was a “who are these guys?” whisper after their scathing research reports were quickly noticed and resulted in publicly traded firms collapsing in value.

Gotham Research’s cloudy background

That whisper turned into an overt scream yesterday when a major financial newspaper published an article outing the firm’s somewhat clouded background. In a statement to ValueWalk this morning, Yu expressed frustration that publicity could damage his business and even endanger his safety. This might not be that unfounded as Carson Block, another hedge fund short seller who publishes research on potential fraud, is said to have expressed similar concerns. Yu would neither confirm nor deny any personal details, however, ValueWalk independently confirmed the identity of Gotham’s founder, but agreed to leave out all details after a request from Yu. He is in the business of publishing research on publicly traded companies he believes are engaged in fraud. This indelicate focus resulted from his personal history of losing on stocks due to deceit and fraud, as was recently reported. This focus translates into the most celebrated research success in the firm’s short history: LETS GOWEX SA (OTCMKTS:LGWXY) (BME:GOW), a Spanish high flying tech stock.

Gotham Research’s report on GOWEX

After Gotham Research published a scathing research saying 90 percent of LETS GOWEX SA (OTCMKTS:LGWXY) (BME:GOW) revenue is “fake” and the company was engaged in accounting fraud, the stock immediately tanked nearly 50 percent – highlighting how, oddly, this firm with a short track record that had an almost non-existent public background could issue an opinion and collapse a publicly traded company. Gowex the firm being attacked wasn’t just any company, but a highly celebrated European technology success story. The CEO, who would later admit to committing accounting fraud, was honored by auditor Ernst and Young with Spain’s entrepreneur of the year in 2011.

Gotham Research Gowex
Chart via Novus Research

LETS GOWEX SA (OTCMKTS:LGWXY) (BME:GOW) had everyone fooled except Gotham Research and Chris Hanson, a San Francisco-based chief of Valiant Capital Management and a “grand Tiger cub” disciple of the original Tiger hedge fund investor Julian Robertson. Valiant was reported to have pocketed a $24 million profit to date on the stock, which Gotham wrote would go to zero in value. That prophecy turned out to be correct, as over the July 4 weekend festivities Gowex’s CEO used Twitter to generate fireworks, essentially admitting that Gotham’s research was accurate, the company was a fraud. The stock price now in freefall, Gotham and its rather abrupt success came into focus in recent media articles across the globe.

Gotham Research a “fraud fighter”

In the articles, Gotham was painted as a “fraud fighter,” among a small group of “shadowy crusaders” who “use the Internet to amplify their criticisms of targeted companies.” “These guys have established quite a lot of credibility,” Alexander Ljungqvist, a professor of finance and entrepreneurship at New York University’s Stern School of Business who has written about short sellers, was quoted as saying. “Investors clearly are taking them seriously.” “Daniel’s achievement here wasn’t just identifying fraud, it was the meticulous documentation to the point where Gowex had no chance” of recovering, hedge-fund manager John Hempton, of Australian firm Bronte Capital, who is friendly with Mr. Yu, said in the Journal article. “That’s no small achievement.”

This highlights one of two questions people have about Gotham: How do they make their money? How did they build their reputation so quickly?

But building a reputation as an activist short seller can have its disadvantages. Yu is guarded about Gotham’s background because it might compromise his effectiveness and expressed frustration over the publicity. “We do not provide (name redacted) with any identifying information about us,” Yu said in a statement to ValueWalk. “In fact, we specifically told her not to do so (publish identifying information).”

Then Yu ponders the meaning of such publicity, speculating on his very safety. “Our request was not honored, despite our warning that doing so would compromise our ability to operate and our safety,” he said. But behind the scenes, it is this publicity that has hedge fund industry tongues wagging about Yu’s bright future. “Gotham has an amazing future in front of them,” said one hedge fund research provider. “They have the power to bring down a public company. That’s amazing.”

Polygon got curious about Gotham Research after Quindell report

It is amazing not only due to the rarity of that power but also the rapid rise to credibility Gotham Research has received. After Gotham Research published scathing research on Quindell PLC (LON:QPP), Polygon, among the more prominent hedge funds who was long the stock, wondered as did many: “Who are these guys?”

Gotham Research Quindell
Chart via Novus Research

In the Quindell research, Gotham accused the European insurance and consulting firm of fraud. The stock promptly tanked, leading people to wonder how a young, upstart research firm without much public exposure could have such power? Polygon, who had been long the stock and speculated about Gotham and their motivations in a private investor letter previously published in ValueWalk.

“What we didn’t expect was a new short side research firm called Gotham (who appear to have been in business for less than two years and provide little transparency about themselves on their website) to publish a 74-page (in our opinion, highly sensationalized) dossier rehashing Quindell PLC (LON:QPP)’s historical red flags, and neglecting to mention any of what we feel are strongly mitigating factors such as the valuation and high-quality new business contracts which we have highlighted above,” Polygon wrote.

“In fact, this report was not fact-checked with the company.” In addition to wondering about how the company grew to prominence in such a short time, there is the issue of how they generate revenue.  Industry speculation previously centered on the firm selling their research to what were estimated to be five large hedge funds while investing in their recommendations as well.

The LETS GOWEX SA (OTCMKTS:LGWXY) (BME:GOW) research report seems to knock the theory that they sell research, at least to large players.  It was their most buttoned up, well documented, slam dunk research report the young firm had written, but there was only one hedge fund reported short the stock, Valiant, who claims not to be a client.  “I would be shocked if someone like Chanos or Einhorn isn’t willing to buy their research,” said one hedge fund source.  “With all this publicity their next sell recommendation could be a lock. If they maintain their quality control – the research is excellently documented and reasoned – those who gain early access to Gotham research could be huge winners.”

Issue of Gotham Research’s revenue generation

Still the issue of how Gotham Research generates revenue is still a question, with the likely answer they are smaller individual investors.  In the LETS GOWEX SA (OTCMKTS:LGWXY) (BME:GOW) short the only firm that had enough size to report to the EU was Valiant Holding AG (SWX:VATN).

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