Short selling – fair play or fear mongering?
This week, we saw WiseTech respond to the latest in what has been a series of short seller “attacks” from overseas funds on Australian companies. This follows recent “attacks” on Rural Funds Group, Corporate Travel Management and Blue-Sky Alternative Investments.
In basic terms, short selling is where a market participant sells shares they don't own in a company (having borrowed them or in some instances without borrowing them, i.e. “naked). They then look to earn a profit based on the difference between the amount the shares were sold for and the amount paid to buy them back. This is equivalent to a bet that a company’s stock price will fall.
In the case of WiseTech, the “aggressor”, an offshore fund named J Capital Research, published a scathing report that alleged shoddy accounting resulting in overstated profit and revenue growth.
The result was disastrous for WiseTech shareholders, with shares in the company falling by 10.2% before being putting in a trading halt on Friday, and falling further 12.3% on the following Monday. The combined share price fall equated to almost $2 billion of lost value.
So, the question is, should market participants be allowed to engage in such a potentially value destructive activity (i.e. should shorting be allowed?).
In recent history “short selling” was, in fact, banned. During September of 2009, in the twilight of the post GFC market crash, the Australian Securities and Investments Commission (ASIC) placed a ban on the short selling of all stocks.
The reasoning behind this was clear – the short selling of stocks at the time exacerbated systematic, fear-driven selling that threatened market stability. This made sense, from the point of view of seeking to reduce market fragility and stabilise “animal spirits” or confidence levels.
Short selling is in all likelihood one of the cogs in the mechanism that helps prevent the irrational exuberance that precedes such a panic. It assists in the process of price discovery, helping prevent the irrationality that can grip the market or purchasers of an individual security.
Ultimately, “short selling” is an expression of a view that a company is over-valued, which is expressed without currently owning the company. This is in contrast to owning a company and believing it is over-valued, in which case you would simply sell.
Such a view provides a counterpoint in a world where institutional research is incentivised to express views that fall somewhere between neutral or positive (hold or buy) and where any alternative view is rare. Furthermore, in all likelihood the view expressed in public by a few that these companies are “overvalued” are held in private by many.
It is up to individual participants that come together to form a market to determine whether there is validity to this view, as expressed in a company’s share price.
While the sequelae of such “attacks” include increased scrutiny and negative press, the period of heightened scepticism that follows is ultimately cause for market participants to re-adjust their focus (and perhaps take off their rose-coloured glasses) and re-assess the value of the company in question.
If that value is there and firmly in place, i.e. the company’s share price is/was justified, the company should pass through that period of scrutiny, relatively unscathed. In the case that the value ascribed by a company’s share price is not there, the “short sellers” have simply brought forward what was an inevitability (and perhaps saved subsequent “greater fools” from buying the next Babcock and Brown, ABC Learning …).
While it is true that short sellers may profit from short-term price action, regardless of the validity of their views, they profit at the expense of those that relinquish their shares in the absence of having a fundamental grasp of the company’s value. That is, they profit at the expense of those who most likely wouldn’t fall under the definition of “investors” in the first place.
In summary, we see it as fair play.