big mac
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July 8, 2001
A Wall Street `Short` Is Part Investor, Part Detective
By ALEX BERENSON
Peter DaSilva for The New York Times
Marc Cohodes, racing fan and risk-taking short-seller, with Jimmy Spencer, left, a stock-car driver, before a recent race.
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EARS POINT, Calif. -- Marc Cohodes, the highest-profile short-seller on Wall Street, is getting bored.
On a warm Sunday in June, the Nascar Dodge/Save Mart 350 here has settled into routine, if the jousting of 750-horsepower cars in the hills of Sonoma County can be called routine. In a trackside tent, Mr. Cohodes and his 14-year-old son, Max, both avid Nascar fans, cheer for Jimmy Spencer in car 26. But Mr. Spencer lags far behind the leaders.
"Let`s go," Mr. Cohodes says.
He slips Max, who has cerebral palsy, into a wheelchair. Then he leads Max and a band of friends onto a service road lined by garages. Five hundred feet later, the garages end, and only a strip of grass, a steel fence and a waist-high concrete barrier stand between the road and the track.
"No Standing," a sign warns.
"I can`t read," Mr. Cohodes says.
A security guard drives by to shoo away the group. Mr. Cohodes promises to go. The guard leaves.
Mr. Cohodes stays. The whir of engines at full boil picks up. The cars come, a psychedelic centipede roaring through a corner and accelerating down a straightaway. In a mesmerizing, acrid blur, they are gone.
"Awesome," Max says. Mr. Cohodes smiles. The security guard returns, insisting that the group leave.
They do. A few minutes later, Mr. Cohodes leads them back again.
Marc Cohodes is a short-seller, and by all accounts he is very good at what he does.
Short-sellers sell shares they do not own, hoping to buy them back later for a lower price. By their nature, they are risk takers, flouting conventional wisdom, pridefully standing apart from the mass of investors.
While long investors want to buy low and sell high, shorts want to do the same, in reverse order.
Shorts dispense with Wall Street`s niceties and break bad news to investors disposed to hear only the good. They are detectives, sifting through balance sheets as they hunt for hidden problems or inflated profits. And they must persist under pressure from executives at their target companies, who often accuse them of lying or breaking securities laws.
Mr. Cohodes, a general partner at Rocker Partners, a hedge fund based in New York that manages $680 million, is not the only short-seller who is respected, even by longs, for his ability to tear apart a balance sheet. And he is not the only short known for his willingness to rip publicly into corporate executives.
But he is among the few shorts who is both. That combination, along with his recent triumph in helping to uncover hugely inflated sales at Lernout & Hauspie Speech Products, a Belgian software company that filed for bankruptcy in November, has made him highly visible at a time when short- sellers are regaining their status in Wall Street`s ecosystem.
The late 1990`s, when stocks soared, were tough on short-sellers. The average short- selling hedge fund fell in four of the five years from 1995 to 1999, according to Hedge Fund Research Inc. In 1999, the typical short fund dropped 24.4 percent; Rocker rose 39 percent.
"The old bull market just about got us all," said M. W. Montgomery, known as Monty and one of Mr. Cohodes`s partners. With longs making fortunes on technology stocks, the shorts appeared irrelevant. Investors showed little interest in hearing shorts` complaints about dubious accounting practices. By early 2000, only a half-dozen funds dedicated to short-selling remained in business.
But the Nasdaq`s plunge has brought new interest in shorting. Short-selling hedge funds gained 34.6 percent last year, according to Hedge Fund Research. This year, they are up 3.5 percent, and a new generation of hedge-fund managers is moving into the practice.
Byron R. Wien, chief United States investment strategist at Morgan Stanley, said he saw strong interest in short-selling when he attended a conference last month. And short interest reached a record high on the Nasdaq market of more than 3.8 billion shares in mid-June, the latest available figure, up almost 3 percent from the May total.
More shorting will probably be good for the markets, Mr. Wien said, because short-sellers research companies more thoroughly than longs.
In the last decade, Wall Street research analysts have grown much more bullish on the companies they cover. Lately, regulators and investors have increasingly complained that analysts are too positive because they fear that their firms will lose investment banking business if they write negative reports — and because they depend on companies they cover for information.
Short-sellers are the ultimate independent researchers, Mr. Wien said.
"I think we all have a lot to learn from the short-seller," he said. "They have to be much more creative about sources of information. But that`s probably an art that every analyst ought to develop."
Mr. Cohodes, 41, is nothing if not creative in his research. He focuses on smaller technology companies with financial results that appear stronger than their products. Then he combs balance sheets and income statements, seeking clues that a company is inflating profits or faking sales.
Is the company making a lot of sales to buyers that are also controlled by its executives, in what are called "related-party" transactions? Are receivables — sales for which the company has not yet been paid — piling up on its books? Do a lot of its sales originate in less-developed countries, where auditors many not be as strict? Has it found ways to hide its costs by categorizing recurring expenses as capital spending? Is it reporting profits even though its cash flow is negative?
Those possible tip-offs are visible on a balance sheet for investors who know where to look. If Mr. Cohodes sees them, he will look deeper, calling the company`s clients and suppliers and asking questions: Do its products work? Does it pay on time? Has it asked customers to buy more than they need now in return for discounts later?
Then Mr. Cohodes considers a company`s management. Does it have a history of puffery or fraud? Have executives sold shares even though they are publicly bullish?
Of course, even a company that meets all these criteria may have great products and a good business. But the more red flags Mr. Cohodes sees, the more excited he becomes.
"High short-interest stocks — that list, over time, is the greatest set of disasters you`ve ever seen," he says, pointing to companies like Iomega, Solv-Ex and Tel-Save Holdings, all one-time highfliers that crashed, just as the shorts predicted.