IN-DEPTH: Ten years of Spruce Point shorts
This article was first published on Activist Insight Shorts on Friday 19 March, 2021. For more information about the module, click here.
Spruce Point Capital Management passed its 10th anniversary at the end of 2020, having spent the past decade weeding out bad corporate actors that feed investors misinformation. As an industry generalist, Spruce Point bounces from investment bubbles to misconceived M&A, and is currently focusing on pre- and post-pandemic deals, as well as the new-found craze around ESG-friendly stocks.
“We follow people and their track records and corporate behavior patterns to identify targets,” Spruce Point founder Ben Axler told Activist Insight Shorts. “We also look at the quality of companies’ financials and are driven by the mantra that if it’s too good to be true, it usually is.”
In the past 10 years, Spruce Point has established a reputation that it is prepared to battle against inflated valuations for some time before its allegations are corroborated, most notably at Plug Power.
Green means go
The short seller published a report on Plug Power in 2019, but despite other investors joining Spruce Point and going short the stock, the company continued to trade at a higher valuation than before the research was made public. Spruce Point founder Ben Axler admitted to Activist Insight Shorts that he may have timed the publication of the report wrong, with Donald Trump’s defeat in last year’s presidential election giving new wind to a bull market in ESG-friendly stocks, but Axler is “confident Plug Power will continue to not make money and will continue to disappoint.”
Indeed, Spruce Point finally hit its target when Plug Power shares lost around 25% this month on an announcement that it would need to restate three years’ worth of accounts and miss its 2020 filing deadline.
More recently, Spruce Point went after American Battery Metals and Comstock Mining. In its report on the companies, the short seller said that it had observed recent outsized gains in clean energy stocks, notably those tied to electric vehicles, and hype around the industry that is artificially driving valuations.
Messy M&A
Axler told Activist Insight Shorts that the fund is also keeping its eyes peeled for companies carrying out acquisitions poorly, particularly Leidos Holdings. In February, the short seller accused the American defense and biomedical research company of misleading shareholders regarding its recent $1 billion acquisition of L3Harris Technologies.
The short seller told Activist Insight Shorts that he believes Leidos “dramatically overpaid” for the business, tethered to airports and global air travel in February 2020, pre-COVID.
Axler added that companies which struck deals prior to the pandemic have been “fertile ground” for short targets, along with those that continue to do deals now. “With valuations high, there are incentives for companies to overpay for businesses and buy low-quality growth,” Axler said. “We’re focused on those.”
Market disillusionment
Axler’s interest in M&A started early on in his career. After working as an M&A investment banker, Axler opened his own fund for long investments in cheap stocks following the 2008 financial crisis. However, the investor found that a lot of the easy money had already been made, while dodgy deals made by Chinese companies raising capital in the U.S. markets, were flying under the radar.
In 2010, Axler began switching his strategy to the short side to change the narrative of companies he believed needed to be avoided by investors. “By 2011 I was focusing exclusively on shorts,” the activist told Activist Insight Shorts. “I believe it’s an underserved market and I feel passionate about the fact that the traditional research model on Wall Street doesn’t work properly.”
During his time in M&A advisory, Axler realized that acquisitions are difficult to do but even harder to evaluate. Meanwhile, reports written by research firms on public companies are paid for by said companies and are not necessarily independent, nor do they provide unbiased research, so investors are not given the full picture, Axler says.
In its fight to change the tide, Spruce Point released its first report against Chinese company ZST Digital Networks in 2010 and within a year of the short seller’s report, ZST’s share price fell around 73%. On April 16, 2012, the company voluntarily delisted its stock from NASDAQ. Spruce Point has since run a further 87 campaigns, according to Activist Insight Shorts data.
The next 10 years
Despite Axler’s decades of industry experience, it is difficult at times to get his voice heard. With asset management moving towards passive investing and government stimulus pushing unsophisticated investors into the market, logic sometimes fails. “There is a belief that stocks can only go up,” Axler told Activist Insight Shorts. “That to me is a symptom of rates being too low and banks being too accommodative.”
While this environment has allowed some targets to live to fight another day, with the average stock targeted by Spruce Point rising 20% a year after the campaign began, the short seller’s one-week campaign return is a respectable 6% (indicating that stocks fell), according to Activist Insight Shorts data.
As the economy reopens and consumers begin to spend money again, Axler reckons the Federal Reserve will eventually raise interest rates and valuations will normalize. But with Axler’s typical persistence, Spruce Point is looking forward to another 10 years of successful short selling.