Throwing pennies in front of a steamroller

One of the annoying things about short selling is that frauds and stock promotes will occasionally be taken private, causing short sellers to lose money on their positions.  If a company announces a going private transaction or other takeover event, my opinion is that the best strategy is to cover your short position and redeploy that capital into other shorts.  Looking back at Chinese reverse mergers, it seems that almost every going private transaction closed.  There were a handful of non-binding going private transactions that didn’t close; those were the only ones worth betting against.

I believe that binding take-over proposals are situations where the fundamentals have very little relevance.  The determination (or stupidity or corruption) of the buyer is largely what drives the probability of these deals closing.  If there is a binding proposal, the buyer has likely already performed their “due diligence” (or lack thereof).  If the buyer didn’t perform their due diligence before signing a binding proposal, they likely will not perform their due diligence after signing the proposal.  One exception that I’m aware of is Freeport McMoran’s deal to buy a stake in the Bre-X deposit.  Freeport already had strong suspicions about Bre-X.  So, Freeport paid millions of dollars to obtain new drillcore on Bre-X’s deposit.  Because they spent millions of dollars on due diligence, they were able to discover the Bre-X fraud.  They were able to back out of the deal because they had protected themselves in their contract.  (*I did not actually read their contract.)

In theory, you can bet against companies that make dumb acquisitions.  Usually this is not a great idea because the magnitude of the fraud is very small relative to the acquirer.  Instances like HSBC/Household and HP/Autonomy don’t end in complete disaster for the acquirer.  In rare cases, an acquirer might immolate themselves with a dumb acquisition that moves the needle.  The guys who bought Canada Lithium traded their pile of cash for a pile of bankruptcy papers.  (Unfortunately I did not short RB Energy and I cannot short Peter Secker’s new lithium company.)  So perhaps a case can be made for being stubborn and shorting dumb acquirers.  However, this universe is very small and I can’t be bothered to figure it out.

The bottom line

Betting against really dumb acquisitions does not seem to be a good strategy.  Sometimes fundamentals do not matter.

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2 thoughts on “Throwing pennies in front of a steamroller

  1. Pingback: As commodity prices plunge, miners are stretching their numbers – Glenn Chan's Random Notes on Investing

  2. Pingback: A China XD Plastics follow-up – Glenn Chan's Random Notes on Investing

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