Interview with Muddy Waters’ Carson Block on his his short bet against Sino Forest and other short positions from a speech at Absolute Return Symposium in New York. – below is a transcription of audio – we used good software but there might be some errors. Either way enjoy! And the slides can also be found below.
And for a good summary of the speech check out Julia La Roche of Business Insider’s coverage
Introducer: Our next speaker has profited from shorting a large number of companies in many different regions using an intense research process designed to uncover frauds and broken business models. Carson Block is a noted short seller and founder of Muddy Waters capital. He rose to prominence in 2011 when his short bet against Sino Forest brought the group’s business model and question. The firm researches accounting fraud, business fraud and fundamentally flawed companies. As well as short activist campaigns. Please welcome Carson Block.
Carson Block: First of all, thank you for having me. Wall Street has never liked short sellers but they’ve been tolerated so long as they abide by this gentlemanly code; take your position but don’t try to embarrass the company. Okay you can go out there and talk to reporters who want to cover the story but don’t go out there and shout of the top of your lungs what’s wrong the company.
The problem is, getting run over. Some of the best shorts have managements that are unethical or crooked and the problem with shorting those companies is they’ll stop at nothing in order to ramp the stock value. So it is very easy to get run over as a short seller that is not out there voicing his or her views.
[drizzle]A few years ago I met one of the titans of the hedge fund industry, a legendary investor, and his quote was, “I used to short more stock than any person alive. And I always did the research, but after 20 years of shorting my book net net was flat.” The reason for that is because there is so much firepower on the other side. Crooked companies will do whatever it takes to support their stock price.
I’ve seen this first hand with Sino Forest. Sino Forest actually spent $50 million trying to discredit our research. That included the chairman of the firm involving a PRC law firm, reputedly a reputable one, to put together a report that exonerated him. Now, The bankruptcy court that is dealing with Sino Forest is currently suing the chairman and has cited this report in its case. So there is a lot of firepower on the other side.
Luckily, the Internet has done a lot to level the playing field the Internet has really democratized investment research. Now when people put these ideas out on the Internet it doesn’t matter which firm they work at or where they went to school all that matters is the quality of their research. I know this very well. I left the industry in 2001 and when I started Muddy Waters in 2010 I was living in China and I was an entrepreneur. I started the first self storage company in mainland China. The plan was to start Muddy Waters, raise lots of money and become a force to be reckoned with but that didn’t happen. What actually happened was, when I started Muddy Waters I was a guy managing a self storage company in China.
One year later, Bloomberg named me one of the most influential people in finance, I was up there with Ben Bernanke, Warren Buffett and so on. So that is the power of the Internet.
It all began with a company called Oriental paper and my father who was an analyst at the time was looking at these micro-cap Chinese companies that were listed in the US. So he asked me to look at Oriental paper for him and he thought this would be a great long. The company listed a number of companies in its 10-K as its main competitors. The company manufactured the brown paper that goes in cardboard boxes. When we saw pictures of the company’s factory (as shown on slide) you can see that their equipment looks like old toys, nothing like the similar, more up to date equipment competitors were using. They had valued this equipment and $50 million. Raw materials inventory, which was literally a pile of trash, was valued at $5 million. That’s a picture (as shown on slide) of my consultant climbing the trash pile and when he came down his exact words were, “if this is worth $5 million the world is a much richer place than I ever knew”.
So on June 28, 2010 my life changed forever because I took all of the research that I had done on Oriental paper and put it into a 30 something page report and sent it out. It was originally a small distribution list. There were about 50 people in the investment industry that I had last spoken to around nine or 10 years earlier and probably most of them knew me as Bill Block’s son. Within 48 hours the stock dropped 55%. Here’s a long-term chart of the company’s stock price and often when you short something you will see a sudden spike backup soon after the initial short thesis hits the wires. And the reason for this is is that these companies are going to fight back with everything that they have. You’ve backed them into a corner and they are going to come out swinging. And that’s why you get a ramp. The idea with a short selling campaign is that you put so much pressure on the company that things fall apart pretty quickly. Maybe it will be the fact that the auditor can no longer continue to work for the company, people might resign or stop working with the company. So that’s why you get the ramp and then the stock begins to fall again.
Today we have around 30,000 followers on Twitter and about 15,000 people signed up on the distribution list. So the Internet is a very important tool I think even more so now than the distribution list. There are algos linked to twitter accounts like those of myself that are programmed to trade as soon as the ticker is entered. Which is actually pretty scary when you think about it.
When I talk to investors there are a lot of misconceptions about what a good short is. The hallmark of my trading is we’re looking backward and most of the investment industry is trying to figure out what’s going on in the future. Much respect to those who, do but I think that’s a very hard thing to do. I want to look at the information that the company has disseminated whether it be in financial statements in transcripts and what have you. I want to ask whether that information is accurately reflecting what is really going on in the business. So you can have delta between reality and information and investors perspectives because you can have, in my opinion two different types of fraud. Actual fraud, which is the legal definition of fraud, or intellectual fraud