Tide turns against short-sellers

Date: Monday, April 30, 2007
Author: Michael Mackenzie and Richard Beales, Financial Times

Short-sellers are facing growing structural barriers in their quest to profit from share-price declines, a reversal of fortune that helps explain the heavy losses suffered recently by hedge funds that bet against Amazon, the internet retailer.

The hurdles for short-sellers range from the rise of private equity buyers, which are taking cheap or poorly managed companies out of the public markets, to the explosive growth of corporate share buy-backs, which are sapping liquidity and exaggerating price moves.

This year, hedge funds that specialise in shorting stocks – meaning they sell stocks they do not own and profit by buying them back at lower prices – have performed less well than funds with other strategies. Short-sellers lost money in March and analysts believe that April proved a particularly cruel month as stocks rallied.

“The Achilles’ heel of the hedge fund industry is on the short side,” said Charles Gradante, co-founder of the Hennessee Group, which tracks hedge fund performance. “Hedge funds are finding it difficult to locate badly run companies that are good candidates for shorting.”

The result is that short-sellers are growing more likely to target better-known companies, such as Amazon. In this case, traders say, short-sellers saw an opportunity because of the volatility of Amazon’s quarterly earnings and management guidance.

Before Amazon released its first-quarter results last week, short interest in the stock was about 48.5m shares, 12 per cent of its outstanding float, according to data from Nasdaq. This was the highest level of short-selling in the stock since 2003.

Mr Gradante said some hedge funds gave up shorting Amazon last year but “die-hard shorts stayed and they have been burnt.” When Amazon’s results beat expectations, a surge in the stock price forced short-sellers to capitulate. Its shares rocketed 27 per cent on Wednesday, and rose 11.3 per cent on Thursday.

Compounding the problem for short-sellers is the fact that two-thirds of Amazon shares are held by a handful of investors, making shares harder to come by in the open market, analysts say.

“Corporate America is announcing float shrink at a record pace this year,” said Charles Biderman, chief executive of liquidity research group TrimTabs. He said buy-backs so far this year had already hit more than 40 per cent of last year’s record total and exceeded the full-year levels of 1995-99.