Carson Block: Biggest Calls From The Muddy Waters Short-Seller

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Carson Block is currently one of the most notable short sellers and activist investors in the eyes of the investment public. He has hit some notable home runs, including most recently with his exposure of fraudulent accounting practices at Luckin Coffee, once thought to be the “Starbucks of China.” He remains best know for the 2011 call that brought his name and that of his activist investment firm Muddy Waters Research to major prominence: Sino-Forest, a fraudulent Canadian-listed Chinese company that claimed to be the largest forest plantation owner in China.

Carson Block is an American researcher who focuses primarily on Chinese companies due to his vast previous experience as an entrepreneur in China. He previously operated a self-storage company there and even wrote the book on “Doing Business in China for Dummies.”

Unlike a long/short equity fund manager like Steve Eisman, Carson Block is entirely focused on bogus companies that make for short targets. His firm, Muddy Waters Research, will publish reports recommending shorts in specific companies that they have researched and now offer investors the opportunity to participate in profiting from their ideas through the Muddy Waters hedge fund (Muddy Waters Capital LLC) launched in 2016.

Carson Block made major headlines earlier this year for promoting an anonymous report that correctly assessed that Luckin Coffee executives were cooking the books as it related to sales and revenue numbers. For more information on the ongoing Luckin Coffee situation, visit our article on the topic.

But what others short calls did Block make to get to this point? See below for some of his biggest past calls and newest targets. We’ll keep this article updated to provide the latest calls here.

Sino-Forest (2011)

This is the call that made Carson Block and Muddy Waters a household name to most Western investors. Before Muddy Waters’ research report uncovered this massive fraud, Chinese companies were still relatively attractive prospects for global investors seeking growth at a time when most Western markets were still struggling to shake off the effects of the Great Financial Crisis (GFC).

Sino-Forest was an example of one such promising company, attracting investments from major investors such as John Paulson, the hedge fund manager who profited from shorting mortgage back securities during the financial crisis. His firm, Paulson & Co. was so high on Sino-Forest that it owned up to 14% of the company before Muddy Waters report, according to news reports. Paulson & Co. would eventually dump their entire position in the wake of Muddy Waters report that compared Sino-Forest to a fraud on the level of Bernie Madoff.

The report, published on June 2nd, 2011, noted that Sino-Forest had been engaged in fraud since its establishment of its reverse takeover (RTO) that allowed it to list on the Canadian market. Muddy Waters alleged that Sino-Forest’s convoluted corporate structure allowed it to obscure its operations from auditors, while at the same time massively overstating the size of its assets, in one case overstating the value of its timber investments in Yunan Province by $900 million.

The report ultimately went on to accuse Sino-Forest of a multi-billion dollar Ponzi scheme, covered up by institutional support and a supposedly solid management team that consistently beat quarterly earnings.

The day after the report was published, Sino-Forest shares lost nearly two-thirds of their market value, and days later Canadian authorities announced the company was under investigation. Within two months of the report being published Sino-Forest’s CEO resigned. On March 30, 2012, the company declared bankruptcy, well under a year after the original Muddy Waters report was published.

The accusations of fraud made in the report were ultimately confirmed by the Ontario Securities Commission (OSC) which found that Sino-Forest and four of its executives, including its CEO, Allen Chan, were active participants in a long-term fraud.

The legacy of this fraud established Muddy Waters’ reputation as a top short-selling firm and also shattered the illusion of many investors who had hoped Chinese small-cap companies would be the “next big thing.” Investors and regulators became more aware of a major problem regarding RTO fraud, where Chinese companies would use Western corporate shells in an attempt to obscure their true operations from auditors and the investing public.

Muddy Waters original report on Sino-Forest is still available on their web site for download here.

NQ Mobile (2013)

Not long after the firm’s massive success with their Sino-Forest call, Muddy Waters initiated coverage on NQ Mobile as a “strong sell,” which understates just how negative Block & Co. was on the stock.

NQ is a massive fraud. We believe it is a “Zero”. At least 72% of NQ’s purported 2012 China security revenue is fictitious. NQ’s largest customer by far is really NQ. Our research estimates that NQ’s real market share in China is only about 1.5%, versus the approximately 55% it reports. We estimate that its China paying user base is less than 250,000, versus the six million NQ claims.

Excerpt from Muddy Waters summary of report on NQ Mobile

They didn’t mince words, did they?

NQ Mobile was an NYSE-listed Chinese mobile security company, and once a high-flier, listed in Deloitte’s Fast 50 China Program, recognizing its extraordinary growth. But the extraordinary growth that made NQ a hot commodity from China to Wall Street was allegedly fabricated, with Muddy Waters claiming that NQ’s market share in China was closer to 1% than the 55% the latter claimed. The shares, which had gained 280% in the year leading up to the report, promptly loss 50% of their value in the wake of the report.

The company never recovered, despite their own investigations clearing themselves of any wrongdoing and threats to sue Carson Block. The stock had lost 80% of its value by 2016 and an unsuccessful rebrand to Link Motion Inc, which aimed to focus on smart driving technology never took off.

Ströer (2016)

Muddy Waters strayed from their focus on China stock frauds when they highlighted their short position in Ströer, a German out-of-home (OOH) advertising company that focused on physical display advertising. Block justified his focus on the company by stating that the executive team at Ströer “had engaged in more highly questionable self-dealing than we’ve ever seen outside of a Chinese company.”

What exactly is “self-dealing?”

Muddy Waters went on to describe exactly what they meant in their press release summarizing the report:

Ströer’s governance reminds us of some of the companies we researched in China. In one instance, Ströer agreed to buy a company from insiders before the insiders themselves even purchased it. Because of the way the transaction was structured, it is impossible to say how much profit the insiders made; however, we believe approximately EUR 22.5 million on a EUR 2 million cash investment made just six months earlier is a reasonable estimate. Insider-affiliated companies are both users and suppliers of Ströer OOH advertising locations, which we think is inappropriate; and further causes us to be concerned about whether sufficient internal controls exist.

Excerpt from Muddy Waters press release announcing short position in Stroer

The bearish thesis on Ströer went beyond questionable acquisitions and to the heart of the company’s digital strategy, which investors had previously bought into and rewarded with an increasing share price.

The report questioned the metrics of the company’s “digital transformation” as the traditional advertiser sought to modernize its operations through numerous acquisitions focused on online advertising. Muddy Waters accused the German firm of drastically overstating its digital revenues and growth rates and pointed out numerous issues with their accounting standards, which the researchers indicated was either “the result of incompetence or an attempt to mislead investors.”

Looking at the stock performance of Ströer (ticker: ETR:SAX), we can see that the Muddy Waters report did have a significant impact on the share price when it was released in April 2016. The stock declined throughout 2016, from a high of around 57.00 Euros before the report was published, down to a low of about 35 in December of 2016. However, unlike many other of Muddy Waters’ targets, Ströer was able to shake off the negative report and the shares rebounded beginning in 2017. Today, the shares trade higher than at the time of the report, indicating that the market didn’t fully buy into the Muddy Waters analysis.

Why were Ströer shares resilient compared to other short selling targets of Muddy Waters?

It’s possible that some investors were less willing to fully accept an analysis of a non-Chinese company by Muddy Waters. The report itself used slightly less strong language in terms of accusing the company of outright fraud than in previous cases such as with Sino-Forest and NQ Mobile. Finally, it’s possible that much of what the research picked up on was basic sloppiness in accounting but not a conspiracy to mislead investors.

Prothena Corp (2017)

Muddy Waters turned its attention to biotech stock Prothena (ticker: PRTA), a company developing a seemingly promising drug for a condition known as AL amyloidosis, which had no available cure. The potential for a proven therapy would be a major success for the company and one that its entire enterprise value was tied up in. Wall Street seemed to expect a positive outcome for Prothena’s drug results and as a result, the company’s shares traded as high as $67 per share in the weeks leading up to Muddy Waters report casting doubt on its main drug.

Muddy Waters’ criticism of the Ireland-domiciled Prothena was multifold: it questioned not only the efficacy of its main drug for treating AL amyloidosis, NEOD001, and allowed that even if it was wrong, the pricing model for such a niche drug would not allow the company to hit its best-case sales targets that Wall Street seemed to be pricing in.

Unfortunately for Prothena, their one hit wonder drug was indeed a dud, as Muddy Waters alleged in their report. In April 2018 Prothena’s shares plunged 70% in a classic biotech crash, as NEOD001 failed a crucial clinical trial.

Prothena, while still trading today, is a shell of its former self, with its shares trading at a fraction of previous highs in 2017.

The result was an enormous win for Carson Block, and a huge loss for Prothena’s main backer, Neil Woodford, a UK-based fund manager who held 8.6% of Protehna’s shares at the time of the failed trial and began a major fall from grace for one of Britain’s most notable investors. In fact, the Prothena episode was just a prelude for more drama related to Muddy Waters, as the short-seller next targeted Burford Capital, Woodford’s second largest holding in his fund portfolio.

Burford Capital (2019)

Burford Capital, a UK-based specialist in litigation finance, which funds lawsuits and then takes a percentage of any subsequent settlements, came under fire from Muddy Waters on a number of fronts. The bearish report accused Burford of grossly misrepresenting its return on capital, questioned its accounting and even took issue with the firm’s CFO being married to the CEO.

The bad publicity from being targeted by Muddy Waters had an immediate and predictable impact on Burford’s share price, which dropped 65% in the 24 hours after the bearish report was published.

Investors may have been more willing to quickly jump ship from the company as it was so closely associated with Neil Woodford, who was in the middle of his fall from grace as a star fund manager. Woodford’s funds kept turning up more and more questionable and illiquid holdings and the added association of Burford being targeted by a short-seller with the reputation of Carson Block was likely a “sell first and ask questions later” move by many skittish investors.

Like most of Muddy Waters’ short targets, Burford Capital’s stock has paid the price, today trading on the London Stock Exchange (LSE) at roughly one third of where it was before the report was issued last year. Burford’s executives have remained defiant however, denying the allegations leveled at it and even seeking a US IPO later in 2020.

GSX Techedu (2020)

Muddy Waters initiated a short position on the Chinese K-12 after-school tutoring service GSX Techedu (ticker: GSX) in May of 2020. Calling the company a “near total fraud,” the main basis of the short thesis is that GSX is allegedly faking up to 80% of its customers through the use of bots. Muddy Waters downloaded GSX class data to make the analysis and further corroborated their conclusions with a former manager that worked at the company. Further accusations include that GSX is understating its expenses and corporate governance issues from its Chairman.

The GSX call has been a roller coaster ride for Muddy Waters and those who followed the analysis and shorted the company as a result. The stock traded at around $32 per share when the call was made and briefly dipped below $30 in the wake of Muddy Waters publishing their analysis. The stock then began a summer surge in early June, peaking at more than $131 per share in August. The stock then began a sharp decline and has been on a continuous downtrend, but still trades markedly above its price at the time of Muddy Waters short call at around $66 per share in December 2020.

Carson Block addressed the strong stock performance of GSX over the summer with multiple media outlets including Bloomberg TV. In that interview he reaffirmed the short call, noted that most of the performance was related to technical reasons and the options market, along with friendly support form a major Chinese brokerage house. “At the end of the day, it’s a fake company,” he said in the June 2020 interview.

These are some of the most notable calls from Carson Block and his firm Muddy Waters. We will keep this article updated with new calls as they become available.


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