What Solomon Lew’s Myer raid teaches us about short sellers

Single-resource miners are a regular favourite.

Solomon Lew, left, sent a tremor through the market by buying $100 million worth of Myer stock. Picture: David Geraghty

Picture this. Earlier in the week, retail tycoon Solomon Lew, sitting in his Melbourne office tower, plotting all sorts of mischief, buys $100 million worth of Myer stock.

At a stroke, three things ­happen.

• First, he sends a tremor through the market — what’s he going to do? Nobody knows yet … including the extremely concerned management regimen at Myer led by chief executive Richard Umbers.

• Second, the stock jumps more than 10 per cent … Lew could sell on Monday morning and make a tidy profit.

• Third … and this is the beauty … he got the stock cheap partly because there has been a massive short position built in Myer.

In fact, Myer until very recently had been the single most shorted stock in the market: even now 14 per cent of Myer stock is held by people betting the stock will go down.

To put it simply, the thousands of investors, many of them day traders, who piled into Myer on a big fat bet the department store group was finished have bankrolled billionaire Solomon. Moreover, as Lew and his Premier Investment company made money, the snorters have been minced. They now have to cover their positions and they will lose a lot of money in doing so.

The Myer story is a milestone: Until now the practice of shorting in the local market has been ­arcane but now it moves into the mainstream.

Lew’s raid actually coincided with even more spectacular action from the US-based Glaucus hedge fund, which came into the market recently and targeted sandalwood producer MFS (now Quintis).

The Glaucus shorting set piece has played out beautifully. The US fund plays the same game in every market: It announces its arrival, then reveals its target (after it has taken a big short) and then invariably the stock drops like a stone.

At Quintis, where the stock has fallen already from $1.30 to about $1.13, the drama has been enhanced by the sudden resignation of chief executive Frank Wilson. (He is planning to launch a takeover, though whether that will come to pass remains to be seen.)

Sell high, buy low

If you don’t understand shorting, here’s my favourite definition from Ray Scott, who runs the excellent free site www.shortman.com.au: “It is a method where you sell first and buy later. If the price of the stock drops, then you are selling for a higher price than you bought for so you make a profit.” (You can sell first because you borrow the stock and pay a fee for doing so … the ultimate lenders of the stock are often big super funds.)

Maybe you don’t agree with shorting. Perhaps you might think it is unfair … Harvey Norman’s Gerry Harvey was quoted in this newspaper a few says ago saying: “Some shorters are acting like criminals.’’

There is an equally legitimate argument that says shorting is a useful truth serum in any market … bad companies who hide scandal, corruption and incompetence can be found out by snorters.

On a more prosaic level, companies that are simply overpriced will be brought back to earth. A good example might be Bellamy’s, the infant formula company that regularly appeared among the most shorted stock a year ago when it was trading at $16. Today it is trading at $4.47 and the shorts have moved on to pastures new.

For investors, it’s time to make a decision: play or don’t play. Many investors in fund managers now seek funds that at the very least are long/short … that is they have the facility to short stocks if they think it will add to the bottom line.

Separately, every investor needs to know whether a stock they favour is on the radar for the shorters. For example, if you are a buyer of Nine Entertainment stock, it really is a relevant fact that 10 per cent of the shareholdings in Nine is being held shorts.

Just a few days ago we had a new No 1 most shorted stock, Orocobre Ltd, which is a pure play on the ASX for lithium. Now there is endless commentary in investment media about the enthralling prospects for lithium, a key component in the manufacture of everything from smartphones to electric cars, and investors might easily be seduced by these prospects. The same investor would be well served by digesting the fact that 20 per cent of Orocobre’s stock is held by traders betting that the lithium hopeful is riding for a fall.

Single resource focused mining stocks are a regular favourite of shorters because the interaction of these stocks and the underlying commodity price of their resources are so easy to read. Western areas, which is 18 per cent shorted, is a nickel company. Syrah resources, which is 14 per cent shorted, is a graphite company.

Of course, the shorts don’t always get a clean result: Glaucus, which has moved on Quintis, wins most but not all of its big bets … and losing bets in this game are very expensive. That’s because while the downside on traditional long stock investing is limited — the most you can lose is everything you invested — shorting losses are theoretically infinite. A stock can rise to any heights and you have to buy it to cover a shorting position.

Perhaps the sweetest victories come to management who beat off the shorts through running their business better than anyone might have expected: in July 2011 the most shorted stock was JB Hi Fi. It was $15 at the time …. today it is $24.80 … ouch.