Short Attacks – the Hidden Costs for Companies

By Dan McDermott

Activist hedge funds have spurred an industry. Proxy solicitors, PR firms, law firms, investment banks, and governance consultants all have dedicated activist shareholder practices that either defend corporate issuers from activists or help activists achieve their goals. The fees can be significant — Browning West’s campaign against Gildan Activewear was estimated to cost the company $77 million.

Despite the ecosystem of advisors either advancing or resisting activist campaigns, a lesser followed corner of shareholder activism — short activism — often poses larger risks to issuers both reputationally and financially.

The short attack: more frequent and more costly

Short activism, or short attacks, are far more frequent than proxy contests. In 2023, there were 110 different short attacks and only 27 proxy contests globally (excluding closed-end fund activism), according to ISS Compass. The lower number of proxy contests is largely a reflection of companies and activist shareholders’ ability to arrive at a settlement agreement in advance of a vote. The fact is, while companies and activists may battle in a proxy contest, they fundamentally have the exact same goal – to improve stock performance.  Therefore, they also have the ability to assess vulnerabilities and proactively take steps to sufficiently alleviate activist investor concerns. Short attack targets typically don’t have the same profile. Companies targeted by short attacks are often outperforming their peers and they most certainly do not share the same goal, as short sellers profit only when the stock declines in value.

In 2023, average proxy contest cost for issuers was $5,342,259. The most expensive proxy contest that year was Trian’s campaign against Disney, which was estimated to demand $40 million in advisor fees. Advisory fees on short attacks are generally not disclosed but can include internal investigations, accounting restatements, PR fees, defense against shareholder litigation and, in some cases, bankruptcy-related fees.

While proxy contests both occupy management’s time and can rack up costs quickly, rarely, upon initial announcement of an activist campaign, does a company’s stock price drop dramatically. The market reaction to a traditional activist campaign announcement can be negligible or, in some cases, be very positive. Following the announcement of an activist campaign from some well-known activists, a company’s share price may jump 5-10% in the first 24 hours.

Short attacks, in contrast, tend to have a negative effect. In 2023, the average one-day market reaction to a short attack was -7.1%, according to Factset Market Data. However, the range of effectiveness of short attacks varies widely. Of the 110 short attacks in 2023, 23 companies did not have a negative market reaction to the announcement. Alternatively, 24 companies’ shares fell more than 10% the day following the short attack with the largest being a negative 83.6% free fall the day after Hindenburg Research’s attack on Maison Solutions.

While the effectiveness of short attacks varies, Hindenburg Research’s short attacks dealt the most damage in 2023 with an average one-day and one-month market reaction of -23.6% and -26.4%, respectively.

In terms of valuation, Hindenburg’s attack on Adani Group wiped out roughly $100 billion collectively from seven Adani-affiliated companies. Those losses do not include the costs of investigations and shareholder litigation following the attack, which were likely also significant. A few months after the short attack on Adani Group, Hindenburg released a short report on Icahn Enterprises, wiping out $2.9 billion of Carl Icahn’s net worth. If the “Godfather of Shareholder Activism” can be caught off guard by a short attack, most public companies would likely be less prepared if targeted.

Boards and management teams are rarely prepared for a short attack

There is an entire ecosystem of advisors that prepare issuers to defend against traditional shareholder activism. However, boards and management teams are rarely prepared in the event of a short attack despite their higher frequency (than proxy contests) and the massive potential for value destruction.

Traditional shareholder activism is easier to predict and therefore easier to prepare for. Even though the timing of a short attack and who is leading the attack can be unpredictable, the themes of most short attacks almost always fall into three buckets:

1. Valuation. Example: Company is overvalued based on aggressive company projections or unsupported investor hype/optimism.
2. Financial. Example: Unorthodox or fraudulent accounting often associated with recognition of revenue. Conflicts of interest with partners/management/board.
3. Product. Example: Ineffective or harmful product/service, the product/service does not work as described or is potentially dangerous to the end user.

Short attack proactive measures

Given that we can generally anticipate how a specific issuer might be attacked, proactive measures can be taken to make a company less of a target and better prepare it in the event it is attacked. Some proactive measures can include:

• Scenario plan for potential weaknesses or attack points. Where are you vulnerable?
• Do not issue aggressive guidance that might encourage investors and analysts to overvalue your company.
• Adopt conservative accounting practices and be cautious in using non-standard accounting measures which are often “red flags” for short sellers.
• Ensure disclosure controls are effective such that public filings contain all material information, including negative sensitive issues.
• Report bad news and unexpected results or developments as promptly and thoroughly as possible.
• Prepare a “Break the Glass” Communications Plan that includes: the short attack response team; draft press releases for multiple scenarios; and draft communications for employees, customers, suppliers, etc.
• Regularly monitor short interest as a percentage of float. A spike in short interest often precedes an attack.

While most public company boards and management teams are at least aware that they should be prepared for traditional shareholder activism, very few have considered the risks (and preventive measures) associated with a short attack. Given the potential for billions in value destruction, it’s time to start paying attention. After all, an ounce of prevention is worth a pound of cure.

ICR’s Transactions & Special Situations Group has advised more than 30 companies on short defense. Contact us for assistance with proactive measures that reduce the chances that your company will become a target and to better prepare it in the event it is attacked.

Dan McDermott is a Senior Vice President in ICR’s Special Situations Group and is an Adjunct Professor of Shareholder Activism at University of Pennsylvania Carey Law School.