Carson Block thinks before he speaks.
The founder and head of Muddy Waters Research has shorted everything from fraudulent Chinese forestry giant Sino-Forest to his most recent target, a regional bank called Bank of the Ozarks.
The process of finding and researching these shorts is a massive undertaking, Block told Business Insider.
It’s also exciting.
“It’s a bit like solving a puzzle,” Block told us. “You’re really trying to find the pieces and how they match together to make a clear picture of just what the company is doing.”
This is made difficult because of the fact that block and Muddy Waters are activist short sellers. Instead of taking the short position and waiting for the trade to play out, Block goes out and releases extensive reports on why he is short the stock and tries to convince others to join him.
“If you look at a hedge fund that does a lot of short selling, the bar is pretty high in order to start a new short,” said Block. “When you’re doing activist short selling, the bar is a lot higher because you’re not only betting on the company going down, but you’re also trying to tell long investors that their thesis is wrong.”
Finding the short
According to Block, there is no one place where he goes for short ideas, but rather he’ll stumble upon them in the course of his work.
“We’re talking to investors, chatting with other short guys, maybe read about it somewhere, it’s a variety of things,” Block said. “We’re swimming in so much information every day it’s more about sifting through and throwing out what’s not interesting to find what is.”
He said that a “very small percentage” of the ideas he comes across actually make it to the research stage.
When Block then picks up an idea he likes, the first order of business is to create a thesis for the short. The example Block used was his most recent short position that he announced at the Sohn Investment Conference on May 4 against the Arkansas-based Bank of the Ozarks.
“For instance, take the Ozarks short — we had to come up with an idea that is actionable,” he said. “So we said, ‘This company is growing too fast and overextended itself, and that’s not sustainable.’ That then directs the research we do going forward.”
Doing the legwork
Once the thesis is in place, said Block, then the work really begins.
According to him, he has a large team of researchers working to build the case.
Block told us:
Some projects we’ve got guys following trucks place to place to see if deliveries are being made like the company claims. Sometimes we’re going to former employees, customers trying to figure out how the business is actually being run. And then a big part is we do a deep dive into the accounting and financial statements of the company.
He said that the last part, diving into the financials, is critical. He has an accounting analyst who has been by his side for years who breaks down how much the company is making and how it is spending that money. In addition, for many projects, Block will bring in outside accountants and researchers to assist in breaking down the numbers.
Block said that he does a significant amount of legwork himself, but that every member of the team brings a contribution to a presentation.
He was reluctant to share just how many of his original theses make it to the market, but he said that the research process is typically happening for multiple ideas at a time.
“Our people can work on two to three different ideas simultaneously, but everyone is working on them,” said Block. “The intensity of the project depends on where we are with it, if it is in a certain stage it may be getting more focus from the accountants or someone else.”
The work doesn’t end at the announcement of the short, either.
Typically, Block gets a significant amount of blowback when a new short is presented.
“I mean, you look at what Sino-Forest spent, around $50 million, trying to fight back against our campaign — it makes it harder,” said Block. “It’s not just validating a thesis, it’s about looking at what’s going on and saying, ‘What do we need to do to change the market’s mind?'”
This requires months of work, continuing to reiterate the short and find areas in which the idea is getting pushback and address those. And, frankly, Block admitted, it can be tough to convince investors that they were wrong on a stock.
The hard work, however, is fun for Block.
“It’s a pretty high-stakes competition against management to see who can present the most compelling case,” Block told us. “That’s exciting. I like that competition of going head-to-head.”
In the end, he said, whether or not a short works comes down to one thing.
“At the end of the day, truth is a pretty powerful weapon,” said Block. “Truth is strong enough to protect you from a lot of attacks from companies. So as long as that’s on your side, it’s good.”
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