Where there's smoke, there's fire.
No, that's not some veiled reference to Tesla CEO and Boring Company founder Elon Musk's flamethrowers. We're referring to short sellers and the belligerent campaigns publicly-traded companies sometimes choose to undertake to undermine a short seller's thesis. Bad news for companies attacking short sellers: Compelling research suggests that companies which pursue belligerent anti-shortseller campaigns perform poorly in ensuing years. More on that below.
Anti-shortseller campaigns come in many forms. Companies can allege conspiracy and "bear raid" manipulation. Sometimes they suggest short sellers are outright liars (strategically planting bearish media coverage and inaccuracies) or even announce lawsuits against these bearish investors.
Enter Elon Musk.
Make no mistake. The Tesla CEO deserves enormous credit for his vision. He has created a viable market for luxury electric vehicles where there was none with the Model S.
That said, Musk's latest attacks against his critics can (at best) be described as overly "defensive." He has repeatedly attacked critics in the media and tweeted that shorts have "three weeks before their short position explodes" (only to be completely rebuked by the market over those ensuing three weeks).
More recently, after discovering the identity of an anonymous Tesla critic, "Montana Skeptic," Musk reportedly picked up the phone and personally called this critic's boss to complain. The threat of legal action caused Montana Skeptic to "immediately cease writing at Seeking Alpha and to deactivate my Twitter account.”
(This article explains what happened in greater detail.)
Such antagonistic antics seem rather unbecoming of the CEO of a $50 billion publicly-traded company and just downright bad for public discourse. If Musk really wanted to beat back the shortsellers, why not silence them by hitting Tesla's Model 3 production targets?
Mr. Market Punishes attacks on shortsellers
There's ample reason for Musk to tone down his tactics.
Beyond the bad optics of his overly defensive posturing, academic literature suggests that companies pursuing belligerent anti-shortseller campaigns perform poorly over the ensuing 1-year and 3-year period.
A widely-cited 2004 academic paper, published by Owen Lamont, suggests that companies pursuing vigorous anti-shortseller campaigns were ultimately rebuked by the market over the ensuing 1-year and 3-year time horizons.
In 327 different such events and spanning over a period of 25 years, the firms that very publicly attacked shortsellers underperformed the broader market on average by 25 percentage points over the following year.
An explanation for this phenomenon, "favored by the firms used in the sample, is that short sellers are actually manipulating prices, driving prices down over long periods of time," Lamont writes.
But this doesn't hold up to further scrutiny, he continues.
"In the 36 months after any event, the market adjusted returns are -1.48 percent per month, so that the cumulative fall is 42 percent." In other words, the longer-term performance of companies that choose to publicly fight shortsellers is downright dismal.
Furthermore, Lamont adds, the problem with the idea that short sellers are manipulating market prices "is that many of the sample firms are subsequently revealed to be fraudulent. Thus the short sellers are identifying firms having bad fundamental value."
None of the above is to suggest that Tesla, or Musk himself, is a fraud. Instead, what Lamont's study shows is that company executives who so virulently attack shortsellers are likely revealing a more deeply rooted truth: The shortsellers are on to something.
Where there's smoke there's fire.
Click below to watch our analyst Jay Van Sciver explain his Tesla short call.
