TOL - 22nd Mar, 2022

The companies that Wall Street legend Jim Chanos is shorting in 2022

Ally Selby

Livewire Markets

It's not easy being one of the world's most-famous short-sellers. 

As Jim Chanos knows, it takes thick skin to deal with daily negative backlash, and, of course, markets storming "parabolically" higher over the past few years. 

But now the tides are turning, and rather dramatically, according to the 64-year-old Wall Street veteran. In fact, since September 2021, investors have been slowly waking up to misleading accounting practices among the world's most highly valued firms, and their share prices have plunged accordingly. 

And while Chanos is adamant his market predictions should be taken with a grain of salt, he notes that there continue to be several well-loved companies, Tesla included, that still could have a long way further to fall. 

"We have a number of US$100 stocks that we think are probably worthless, because the business model is broken, and yet they are reporting numbers that are not real," he says. 

Chanos founded Kynikos Associates in 1985, which manages a short-only and a hedged portfolio. The name, which references the Ancient Greek "cynicism" school of thought, was suggested by the wife of Chanos' original business partner (who reportedly sold Chanos his share of the business for just US$1). The Ancient Greek "cynicism" promoted the practice of "self-discipline and independence of thought as the way to find true happiness," Chanos says. 

The modern meaning of 'cynic' has clearly evolved but is perhaps even more apt considering the backlash many short sellers face. 

Where long investors - the likes of Warren Buffett, are celebrated for their love of long-term investing in undervalued companies, short-sellers do the exact opposite; they seek out overvalued securities (or those engaged in outright fraud) and profit when a stock plummets. 

Chanos rose to fame after correctly predicting the fall of the energy and commodities giant Enron Corporation, a year before the accounting scandal was publicised and the firm filed for bankruptcy in 2001. At the time, it was considered to be the biggest bankruptcy and audit failure in the world. 

So which companies could be misleading investors today? In this exclusive Livewire interview, you'll get an inside look at the legendary short seller's view on markets, as well as some of the global companies that Chanos considers to be posting fraudulent financial figures and could be in for a rude awakening over the months to come. 

Note: This interview took place on Friday 11th of March 2022. You can watch the video, listen to the podcast, or read a transcript that has been edited for clarity below. 


Edited Transcript 

Ally Selby: Hello, and welcome to Livewire Markets. I'm Ally Selby. And today we have a very special one for you. All the way from Miami in the US, we're joined by Jim Chanos. He's one of the world's greatest short sellers and the founder of Kynikos Associates. He became world famous after predicting the demise of energy and commodities company, Enron. And today he's sitting down to talk to you. Thank you so much for joining us today, Jim. We really appreciate it. For those Aussie investors who may not know you or Kynikos, can you tell us a little bit about the firm and what makes it different to other investment managers and perhaps the meaning behind the name?

Jim Chanos: So I started the firm back in 1985, and the idea was to provide a portfolio of overvalued securities on the short side to hedge people's exposures on the long side. And the idea, it was always more interesting and more lucrative to do that than simply either go to cash or use futures to hedge your portfolio. The root of the firm's original name came from actually my original partner's wife, and she pulled it out of one of her ancient Greek history books. And the Kynikos were a group of ancient Greek philosophers who lives outside of Athens and believed that self-discipline and independence of thought was the way to true happiness. But you would recognise it as the root of the word cynic. They were the cynics.

Ally Selby: It's obviously been a difficult decade for short sellers, particularly over the past two years. Is there any evidence that environment is changing?

Jim Chanos: So it has been. The last four or five years have been difficult really since sort of 2018, but that changed rather dramatically around the summer, fall of last year. And for us, our so-called alpha, how we do relative to the market, which is how we get paid. We have two basic pools of capital. We have our traditional short-only funds. And then we have a hedge version of that, which is hedge with market indices. And the alphas began to expand rather dramatically starting in the late summer of 2021. But the early part of 2021 and most of 2020, it was a nightmare for short sellers. I mean, it was culminating in the meme stocks and the big short squeeze that a lot of companies saw in their equities in January of 2021. But in my view, that was sort of the ending of something, not the beginning of something.

A lot of hedge funds actually covered their shorts when that happened, saying that there was unlimited risk that these kinds of stocks could go up tenfold on you. And our view is a little bit differently. Our view is that was sort of the last gasp of a retail speculative mania in all kinds of assets. But by and large, what we saw in 2021, in late 2020 was very akin to what I saw in 1999 and early 2000 in the end of the dot-com era where stocks began to go up on parabolas, almost irrespective of what the fundamentals were, or with even questionable fundamentals. And that's not something that's usually sustainable for long periods of time.

Ally Selby: What are you seeing on the ground at the moment in the US? Australia is often a few months behind you guys. And where do you see the S&P and the NASDAQ moving from here?

Jim Chanos: Yeah. I mean, my market predictions are worth pretty much nothing. And since we run both hedge and we're running our portfolio as if our clients are long, our idea is to just focus on the companies themselves. I will say, however, to just amplify what I said before is that we did see I think record amounts of speculation in the US stock market last year. And that may take some time to work off. Now, does that mean the market's going down 30% from here? I have no idea. Does it mean we go flat for a while or just returns are pay for a while? I mean, that could be too. I really don't know. But I do know that a lot of equities are still priced for perfection. And companies that we think actually might not be worth anything are trading at 10 to 15 times revenues in many cases, admittedly down from 20 times revenues, but are probably going to one times revenues. So it really that part of the market is still very richly priced.

Ally Selby: Is there a stock that comes to mind that can speak to that?

Jim Chanos: There's lot of them. So we have been infamously short Tesla for years. And to me, it would be one name I would have your viewers just keep an eye on as a bellwether because it reminds me a lot of Cisco in 1999, 2000 when Cisco went parabolic. Cisco made routers and equipment for the internet. But by 1999 and 2000, Cisco was trading at a huge multiple of revenues. And people were just extrapolating out that Cisco would be in all other kinds of businesses that they actually never got into. And although Cisco did fine as a company going forward, the stock collapsed. And with Tesla, you have a auto manufacturer that's trading at a huge multiple of revenues. Most auto companies trade at one half of revenues because they're cyclical. Tesla trades at nine or 10 times revenues, a huge 90 times the estimated earnings.

So investors are still basically putting all their hopes and dreams on this company saying it will be an energy company, it will be a green company, it will be an EV company, it will be an autonomous driving company, and what have you. And so an insurance company, I mean, people are just putting out all kinds of things on the back of this company. And there's usually in every bull market, there's a stock like this that captures the hopes and dreams. It becomes a canvas upon which investors just extrapolate all kinds of things, usually led by a charismatic leader. And I think Elon Musk qualifies as that. And so that's a stock that I would watch as a real indicator of this market.

Ally Selby: I want to go back to do a little bit more macro now. Obviously Russia's invasion of Ukraine is dominating headlines. Hopefully we see a peaceful end to that sooner rather than later. But I'd like to know whether or not you've made any major portfolio changes in the wake of that war starting.

Jim Chanos: Not really. I mean, the war was sort of unexpected three weeks ago, four weeks ago. We haven't changed our exposures in any meaningful way because of it. I think the market is down maybe a little bit since then. It's not down a lot in the US. I still think a bigger macro issue that people should keep their eyes on is the fed and liquidity in the markets that QE just ended literally yesterday by the fed. And the fed has indicated it's going to start raising interest rates. And the question will be how embedded is inflation, which nobody was even been worried about a year and a half ago. And now it's printing kind of crazy numbers. Will it get back to where the fed and the ECB claim it will i.e., 2%? Or are we looking at something that's now embedded at quite a bit higher?

I would point out that if we are going to embed at 2% and US growth now real basis is 2%, you're looking at 4% nominal GDP. And normally 4% nominal GDP would not have 0% interest rates in a 2% tenure. You would have meaningfully higher. You would have three or 4% short term rates in and five or 6% tenure. So interest rates by any stretch of the imagination, even if inflation comes back down are really low. And what investors have to worry about, is that regime changing and will we see higher rates going forward?

Ally Selby: You recently appeared on CNBC and said that right now is the time to be long the indices and short a lot of the craziness. Can you tell me what you meant by that and also where you are seeing craziness or froth right now?

Jim Chanos: Yeah. So again, it gets back to sort of our core belief that there are lots of individual situations at any given time, sometimes more than others, that just don't make any sense to us, right? Investors have just extrapolated out hopes and dreams, or the companies playing accounting games, or something's dramatically changed in the business. And yet, we really don't want to be held hostage to the stock market. So the idea of being long the market and being short, these types of situations has always been attractive to us. So where is that? There are lots of areas with asymmetric risk-rewards right now, as I indicated earlier. A lot of them have to do with the fact that interest rates have been low for so long, and people have gotten used to that. A lot of them have to do with the accounting games we see being played in Silicon Valley. One of the things we've been railing about for the last few years is the increasing use of pro-forma earnings metrics by companies that increasingly are disregarding large amounts of expenses in order to show profits.

So I'll give you an example. A company like Square, the big payments company that just bought Afterpay, which is an Aussie company, the buy now, pay later company. And Square lost money on a GAAP basis in the fourth quarter but reported an adjusted profit. They're supposed to make I think an adjusted basis, a $1.25 this year, with the stock over $100, but that's adding back share-based compensation. If you actually look at the earnings on a GAAP basis, they're supposed to lose money. And that's just a very good vivid example of the number of companies that are paying their employees in stock and disregarding the expense.

Ally Selby: You told about there being a new market regime. Do you feel like investors will continue to accept that adjustment on balance sheets going forward?

Jim Chanos: I think that people are beginning to catch on. So in the case of Block, the reason I bring it up is the stock has gone from $240 to basically a little over $100 in the last six months. So as I mentioned earlier, a lot of these kinds of companies are down quite a bit, but the pro-forma EPS number for 2022 during that same time period has gone from $2.40 to $1.20. So it was trading at a hundred times in October or September, whenever it peaked out, and it's still trading at almost 100 times now, and both of those are questionable estimates because they add back the share-based comp.

Square's actually, as I said, probably going to lose money this year. Or Block, excuse me, is going to lose money this year. So investors I think are catching on and that's why we're seeing some big drops in these kinds of tech names where the growth has slowed and they aren't really making any money. They're just telling you they are because they're paying their employees in stock. And by the way, that's a two-edged sword. We saw that in the early 2000s when the dot-com era blew up. Companies that were aggressively paying people in stock options because they didn't have to expense them in the US, suddenly realised they had to pay people more and more as the stock declined. And there was more and more dilution. And so what was a virtuous circle on the way up, became a vicious cycle on the way down.

Ally Selby: I want to talk about the short that made you famous - Enron. Are there any learnings from this short that you think are still relevant today?

Jim Chanos: So I teach a course on the history of financial fraud at the two institutions over my shoulder. And one of the models of fraud that we talk about came really out of the Enron story by my friend, Bethany McLean and it's her concept of legal fraud. And it's a really important concept. And Enron was the paragon of this idea of legal fraud. And what Bethany said and I teach is that in the financial markets today, almost everything you see that is questionable is technically legal. It's been vetted by the lawyers and the accountants, but yet there's an intention to mislead. If you take all of the legal games that Enron played, every single one of them was signed off by the lawyers and the accountants.

Enron was not prosecuted for accounting fraud, even though the black hole was tens of billions of dollars once they went bankrupt. The insiders were basically convicted for lying to shareholders. And so it's a really important concept that companies have a wide berth to show their results and present their results in a pro-forma manner and what have you. But you have to be very aware that the whole pattern can be to mislead you, to make you think that something is much better than it really is. And I think that's the really important lesson to take away from Enron because they kind of wrote the book on that whole concept.

Ally Selby: Are there any fraudulent companies today that you think are being overlooked by investors or are currently hiding in plain sight?

Jim Chanos: Yes, sure. There are a number of them. I'm not about to reveal them. My clients pay me for something. 

Ally Selby: Okay. Maybe what's your most exciting short position right now then?

Jim Chanos: Well, again, I'm going to just say that we have a number of them. We have a number of sort of $100 stocks that we think are probably worthless because the business model is just broken and yet they're reporting numbers that are not real. And I think any investor right now should really be scrutinising, particularly in the tech area, where businesses are slowing down in terms of revenue growth and the companies are still unprofitable. And yet they're using something like adjusted EBITDA or adjusted EPS to tell you that somehow they're being profitable because not only are they fooling you, they're fooling themselves if they're allocating capital to unprofitable core businesses on the idea that you will value them based on some metric that doesn't reflect reality.

And so you can look at... I'll just give you some companies we were short recently just to give you an idea what I'm talking about. You can look at the Ubers and Lyfts of the world, for example. Well, Uber recently told you that they're going to be adjusted EBITDA positive, I think this quarter or at the end of the year, whenever it was. And yet, if you looked at the actual numbers, that meant they were going to lose about $500 million that quarter. So going from half a billion-dollar real loss to telling people you're profitable is really kind of amazing. Investors should be on guard for that on just how low our standards have gone in corporate America and elsewhere so that we say that we're profitable to this amount. And yet when you actually look at the financial statements, you see that they're not.

Ally Selby: Can I press you for one current short?

Jim Chanos: We've been public on a number of ideas. So I can certainly tell you that one idea that is a blue-chip idea that we've been short for a while and we were short in the past that I think is playing very aggressive accounting games is my friends at IBM. So if you look at IBM, IBM is supposed to be making $10 per share adjusted, and then $11 and $12. Right now we think IBM is actually earning closer to $5. And they're basically barely covering their dividend. And the stock is trading at around $120. So the market thinks it's paying 12 times IBM's no growth earnings at $10 going to 11. The fact of the matter is it's paying almost twice that.

Now it played this game back eight or nine years ago when the stock was $200 and Warren Buffett owned it, and IBM was supposed to make $20 in the coming near future. So investors valued the company at $200, 10 times that number, and they weren't earning anywhere close to that. They were earning only about $10 at that time. And after a couple of years, the company had to finally come clean and say: Yeah, we're not really earning $20. You should reset your expectations down 50%. We think they're going to have to do a similar kind of reset in the near future and reset expectations to well below where people think they're earning right now.

Ally Selby: I'd love to know what has been your most painful investment during your career. Is there one that comes to mind?

Jim Chanos: Yeah, there are two. In the dot-com era, it was AOL, America Online, which ultimately got was an accounting story and ultimately got bought out by Time Warner. I think we were shorting it at $8 and we covered it $80, and then it blew up Time Warner in the merger afterwards. And then more recently, it has to be Tesla. We have thought that this company is over-earning. It wasn't making any money until a couple of years ago in a very competitive field, but we've been wrong on the company and the stock in terms of at least their ability to make money. We don't think 28% gross margins are sustainable in the auto business, but so far he's been able to do it. And investors, as I mentioned earlier, have been willing to give him a absolutely insane multiple to value the company at 100 times earnings and nine or 10 times revenues. So that's been painful.

Ally Selby: Have you covered your position in Tesla? Have you sold out?

Jim Chanos: No, we still have some puts that are out of the money, but I think one day we'll pan out nicely.

Ally Selby: Markets historically go up more often than they go down. I'd love to know how you personally deal with the risk of getting it wrong, or as you talk there about Tesla, getting it right, but perhaps the market continues to push the stock higher.

Jim Chanos: Yeah. So, obviously, we know that and that's why we for the most part hedge our portfolios, right? We're long the indices or our clients are long and look to us to hedge on the short side. And so we get that. However, I would point out one really big caveat to the concept that the market always generally goes up, which is true certainly in the United States, and that is most companies actually over time fail, an awful lot of companies fail all the time. And the average lifespan of a company I believe is something on the order of about nine or 10 years. And so the indices of course are always self-selecting. So they're always picking the largest companies and there are some inherent issues with that as well, but at least you are systematically exposed to the factors that drive equity prices higher while you're discreetly and idiosyncratically short the bad guys.

Ally Selby: Okay. Last but not least for today, I'd love to know, would you advise anyone early on in their career to become a short-seller themselves; to follow your path?

Jim Chanos: No. It's not for everybody. So the story I tell about that is almost all of us are the product of positive reinforcement. If you're raised and your parents, if they're doing a good job or are basically encouraging you to follow your passions, get an education, your teachers do the same thing and all along the path, basically you are positively reinforced throughout your career. And that's great. That's the way society should act. But studies have shown that rational decision making among other things breaks down in an environment of negative reinforcement. Wall Street on a financial basis, Wall Street is a giant positive reinforcement machine. I mean, every day we come in, we're short 40 names, five or six of them are going to have positive research reports.

Analysts raising price targets, the CEOs on TV, there's a buyout rumour, whatever it might be. And it's just sort of the noise of the market, but it's a positive reinforcement machine. They're constantly telling you, you should be owning these stocks. And if you're a short seller, that is basically negative reinforcement every single day. You're coming in basically being told you're wrong. And although the research should be the same, you should be using the same tools as investors on the long side are using. What is the company worth? What are its prospects? How is it being priced relative to those prospects and the risks?

Coming in and every day being told you're wrong is not for everybody. And I used to think that good short-sellers could be trained. And now pretty much 40 years later, I'm of the belief that they can be trained, but you also have to have the ability to sort of drown out that negative reinforcement every day when you come in and just say: Okay, well, I know that Macquarie Bank likes this, or Merrill Lynch likes this, or Goldman Sachs likes this, but they're wrong. They're getting their conclusions wrong and here's why. And so that takes something a little bit different. And not everybody I think is well suited, nor should they be for that. So I think I've changed my view and I think most good short sellers probably are also born as well as me.

Ally Selby: Well, thank you so much, Jim. I've really enjoyed talking to you today. It's been an absolute pleasure. Thank you again.

Jim Chanos: It's my pleasure. Thank you for having me.


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Ally Selby
Content Editor
Livewire Markets

Ally Selby is a content editor at Livewire Markets, joining the team at the end of 2020. She loves all things investing, financial literacy and content creation, having previously worked for the likes of Financial Standard, Pedestrian Group, Your...

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