Short Selling Strategy -- Starting a Panic

One goal of a predatory short seller may be to cause a panic among the enemy.

Let us define the state we want to create. We want a state of fear that is so intense, so frantic, that it overwhelms and dominates thinking to create the actions we want. We want this to be a contagious group state.

So imagine the stampede for the exits when someone yells “Fire!” in a crowded theater. The audience panics and clogs the exits with bodies.

Would you not like the shareholders to panic and run for the exits by selling such that this stampede of selling at any cost drives the stock to next to nothing?

Would you not like managers to be paralyzed and not know what to do? Wouldn't you want them to stop their duties and start frantically circulating resumes?

Wouldn't you want the customers to jam the phones with requests for refunds?

Note that this has to be a sudden, overwhelming attack from which recovery is impossible. Over time, anyone can get used to anything, change, adapt and eventually recover. No! You want smashing direct hit destruction of all systems.

Note also that if the mind is totally taken up with panic, logical thought, productive thought is impossible and wild action, even that which would cause the destruction of the entity involved can happen. The people rushing to the exits can be trampled to death, not having the presence of mind to realize that they need to take other action.

Short sellers can attack various groups: target shareholders, company management, company employees, and customers. They can attack all of these at once.

What causes the type of panic we want?

Real or imagined immediate threats to survival. Not seeing any hope, being unable to move or respond, being surrounded, all are things that can cause panic. Not seeing any prospect for help or rescue. Having too much to handle. Stress. Weakness. Confusion. For unethical companies, the threat of prosecution. The fear that others will sell before you can. 

While a team can help provide its members with courage, panic is a herd disease that infects groups rapidly. Being part of a herd makes you more susceptible.

Being in a new situation makes one more susceptible.

Note also that you can have buying panics. The short sellers are panicked about their losses and want to cover at any price.

Can you protect against panic? At some level, no. Even the most well trained soldiers can fall into panic. However, good training can ward off most panic. Good leadership can stop a panic. Good leaders are immune from herd instinct.

It is interesting to me that some soldiers in a threatening situation will hunker down and fight to the death they know must come, while others panic and run (only to be killed without killing any enemies). Recall the determination of the Spartan 300 at Thermopylae.

In my opinion you find short selling opportunities when you have a bubble caused by investor herd behavior that drives prices beyond all reality, and you the find that this herd is that much more susceptible to panic on the way down. One a herd, always a herd. Herds can be stampeded.

Herbalife HLF Counter Attack

Events are as reported as follows:

Bill Ackman of Pershing Square has been shorting Herbalife (HLF). 

He has been involved in formal investigations of HLF already opened and ongoing by the SEC and FTC.

Now the FBI and federal prosecutors are interviewing people related to Ackman and asking for documents, looking for potential Herbalife stock manipulation, according to The Wall Street Journal. 

It appears that prosecutors in the Manhattan U.S. attorney’s office and New York field office of the FBI are looking into whether people, including some hired by Mr. Ackman, made false statements about Herbalife’s business model to regulators and others in order to spur investigations into the company and lower its stock price. 

The result of this report was immediate and dramatic:

Chart courtesy of Stockcharts.com 

Global Strategy Group, the consultancy firm hired by Ackman, said they are not the target of any investigation into potential manipulation of Herbalife's stock, and Ackman told CNBC's Scott Wapner on Friday that he was aware that Global Strategy Group, a consulting firm he hired, had been contacted by the FBI. Ackman made very clear, however, that neither he nor his hedge fund had been contacted by the FBI or Department of Justice. He reiterated to Wapner his conviction Herbalife was a pyramid scheme and he explicitly said he had made no false statements about Herbalife. 

A lawsuit against HLF for fraud was also dismissed. While it will no doubt be re-filed, but this adds to the bad news for the shorts. The shorts are now on the defensive and find themselves having to explain things. Hence, the stock is strong. 

My analysis:

Ackman has attacked a company with huge cash flow. HLF has had to defend itself over the years against many attacks, including a congressional investigation. HLF is therefore experienced at defense and well fortified.

If you are going to attack a well defended fortress, you do not do it with a frontal attack. 

The proof of this is that even though Ackman was successful in getting investigations going he did so at great cost in terms of his lobbying bill and having to endure being squeezed in the market. 

HLF has outspent him in their lobbying efforts. After all their survival is at stake. 

We think perhaps that now some bulls in the stock are making a counter attack on the bears and have gotten the authorities interested in investigating the bears. Who could have planted, I mean leaked this news to The Wall Street Journal?

The result of this investigation being announced were evident in the jump in price. 

Here we have a case where the company actually counter-attacked. They got a noisy investigation going that has a strong element of threat to the shorts. It is not a defense of their business model, it is a direct threat to the shorts. Public investigations are always a wonderful tool.

The result of this counter attack has been very beneficial for the company. Where denials issued by the company have been ineffective, this public attack on the enemy has been effective. Let this be a lesson to all companies under attack by short sellers. 

We still doubt that this will be much more another temporary back and forth battle between two well financed adversaries. 

HLF is slowly bleeding out  but Ackman is not getting a return on his investment. We think the smart money is on Ackman to win a very long and costly war. Ackman has enough money to keep his short position forever.

The moral of the story is to win by overwhelming the enemy. One overwhelms by making a huge attack that cannot be countered or handled. Surprise is key. You have to attack by getting there "firstest with the mostest."

Trench warfare stalemates are not productive of high return on investment for short sellers.