Tiger Woman on Wall Stree (11 page)

Sunlight’s management team marketed the company with a narrative that claimed it had a proprietary light fixture that reduced electricity consumption and saved its customers lots of money in the process. Its lofty valuation suggested that its management’s pitch resonated with investors who were hunting for additional clean-tech plays in the wake of prior rushes to scoop up solar and wind stocks.

To end the conversation on a high note, the broker added: “John Rogers, a longtime friend of the president of the United States, is one of its largest investors.”

I hung up the phone. I knew from my experiences in both Shanghai and New York City that when people rely on name-dropping, it often means their argument is lacking. In my business, making money depends on the ability to develop a variant or contrarian view from the consensus. You have to break free from the herd and be comfortable operating as a loner. And if people were buying Sunlight merely based on a celebrity recommendation, there might be an opportunity in moving in the opposite direction.

One Sunday afternoon, I came into the office as a part of my weekend routine. I loved to work in the silent office with no one around, with only four big screens staring at me. As I was flipping through Sunlight’s IPO memo, a slew of red flags caught my attention. First of all, Sunlight marketed itself as a “demand response” company—a trendy term meaning that it would be responsive to the needs of the electrical grid. Since none of Sunlight’s competitors made similar claims, it was an important point of differentiation. But as I read and reread the description of its products, I still couldn’t figure out what the secret sauce really was that gave this stock its premium valuation relative to its competition. In fact, the information the company provided on its technology was paltry at best.

I soon found other alarming clues. The CEO (let’s call him Manfred) was a high school dropout. Prior to founding Sunlight, his main experience was as a salesperson for a large industrial company. After he started his own company, he hired his wife to be director of operations with an annual salary of close to $1 million—despite the fact that the company was unprofitable. I smelled trouble.

That afternoon, I posted a question on LinkedIn, the professional social media website that I often use as a research tool. “I
am looking for recommendations for lighting fixtures for a large commercial storage facility,” I wrote. “What’s your opinion on Sunlight?”

The following Monday morning, I received a long e-mail in response to my question from the CEO of one of Manfred’s main competitors, someone I’ll call Ernie.

“They make tons of claims and love to reference their patent portfolio but in the end they have a cookie cutter, one-size-fits-all solution,” Ernie wrote forcefully. He explained that more than 60 U.S. companies made high-intensity fluorescent lighting fixtures that were similar to Sunlight’s and that this competition was putting pressure on all these companies to lower their prices. He also shared the contact information for several of Sunshine’s distributors.

It all started to become clear to me. Sunlight was operating in a commodity business, and the competition was cutthroat. However, to get a high valuation in the stock market, the management decided to spin a clean-tech story by making false claims about how its proprietary light fixtures reduced electricity consumption. They were lying. I had seen this act before, but not to such a blatant degree.

But before I pulled the trigger to short the stock, I needed more data points to confirm my conviction. So I dialed up Sunlight’s distributors and pretended I was a purchasing manager looking for lighting fixtures for several large industrial warehouses in China. When a representative from Sunlight’s largest distributor picked up the phone and, after my introduction, began ripping into the company, I was stunned. “Their fixtures are extremely low quality, and their hardware and software are incompatible,” the man on the other end of the line told me in his midwestern accent. “Their bulbs also break frequently during shipment.”

“That’s terrible,” I said. “But how do they manage to sell so much? Their revenue has been growing nicely.”

“Those guys massively discount their products every three months or so,” he said. “And the CEO is great at marketing. He goes to the trade shows and tells people that his bulbs save more energy than others and that he has intellectual property that no one else has. But we talk to our customers every week, and I don’t think anyone who has used their products has bought from them again. If you want to buy anything of quality, I’d advise you to stay away from them.”

Competitors often bad-mouth each other, but I had never seen a distributor bash the products he carried. I knew I was close to finding a home-run short. After the phone conversation, I borrowed and sold a small short position of the stock at $12 a share.

Three weeks later, Sunlight reported its quarterly earnings. Its revenue came in a staggering 15 percent below the average estimate that banks on Wall Street put out. Its earnings missed Street estimates by even more, as the company’s profits suffered from the pressure put on it by low-priced competitors. According to the company’s balance sheet, its inventory and accounts receivable both shot up significantly—meaning a higher percentage of the company’s sales came from extending credit to customers than from selling products and collecting its money in that quarter. The stock started to retreat but didn’t collapse. Together with the trading volume, this signaled to me that the die-hards were giving the company the benefit of the doubt and hoping this dismal performance was a one-time event.

The next day, analysts started to publish notes defending Sunlight and dismissing the poor performance as a slip-up that could be fixed in the near future. After all the work I had done on the stock, I knew it was not a misstep but a sign that management was cooking the numbers. My conviction was that the company was guilty of “channel stuffing” to meet Wall Street’s expectations. In other words, it was discounting its bulbs significantly toward the end of each quarter, which its distributors called “promotional
sales.” Since the products were of inferior quality, distributors were not able to sell what they bought from Sunlight. As a result, inventory piled up. However, since the products had already been shipped from the manufacturer to the distributors, Sunlight recognized the revenues although its products had not actually been sold through to the final customers. This scheme is one of the most common methods that companies use to cook their numbers. When I added them up, these red flags all pointed to the fact that the company would soon be experiencing a severe deceleration in its sales.

Out of curiosity, I called up one analyst who had issued a strong buy rating on the stock.

“What’s there to love about this stock?” I asked him. “It seems like terminal cancer to me.”

“Well, you know, they are working on the pipeline . . . a bad quarter doesn’t mean something good won’t happen in the future,” was his lame answer.

“Why don’t you upgrade it when good things indeed happen?” I tried to be polite. “For now, it’s a crapshoot. And you are recommending a crapshoot to the Street?”

“Yeah, but . . .”

Over time, I learned that “Yeah, but” is a typical defense when an analyst can’t downgrade a stock he or she knows is bad. Sell-side analysts are often caught in a tricky position: they run the risk of sabotaging the bank’s relationship with powerful companies if they express negative opinions about a stock. Because of this conflict of interest, their ratings always have a positive bias.

“Know your enemies and know yourself and you will not be imperiled in a hundred battles,” Sun Tzu wrote in
The Art of War
. The conversation with the analyst gave me extra comfort that I was way ahead of the crowd in my due diligence, and I added on to my position. In the following three quarters, Sunlight missed its estimates again and again. Eventually the Street’s sell-side analysts
were all forced to downgrade the stock, and its price collapsed to about $3. Since I borrowed the shares at $12, I made a respectable 80 percent profit in less than a year.

Short selling is not hard. It just takes independent thinking and a lot of groundwork to analyze any difference between the company’s underlying business and its perception in the market—as well as the guts to bet against the market. After that, it is all about having the patience to watch as the movie plays out on its own.

O
NE
S
UNDAY IN THE SUMMER OF 2007,
I
WENT TO
B
EST
B
UY TO
perform “channel checks”—analyst-speak for a third-party investigation of distribution channels to verify how well a product sells. This time, I bought my research partner and boyfriend, Andrew, to join me in playing the role of a married couple shopping for a GPS gadget—to help us navigate from Manhattan to our weekend house in Vermont, no doubt.

I had met Andrew, an Irish-born American from North Dakota, at a colleague’s party. Tall, fit, and blue-eyed, Andrew was a senior investment professional at a multibillion dollar hedge fund founded by two former Goldman traders in the summer of 2003.

I remember our first conversation at a cocktail party at a mutual friend’s apartment in Manhattan. We didn’t get along too well: Andrew took the opposite view on a medical device company that I liked, claiming that its heart monitoring technology was ineffective in predicting heart failure. The disagreement led to a dinner at which we planned to exchange research notes on the company. The dinner went very well. We realized that despite our drastically
different conclusion on that particular investment, we had a lot in common. After the non-date date, we quickly became best friends and close colleagues. In 2008, we got married, just about a year after we met.

Most of the dates Andrew and I went on did not take place in restaurants or theaters. Instead, he would accompany me on field trips and to my office over the weekend to brainstorm investment ideas or help me build financial models. Andrew knew how to entertain me—not with flowers and lavish gifts, but with endless intellectual stimulation. For us, a trip to Best Buy to analyze and discuss new tech products was not unusual.

We were there that day to investigate Garmin, a U.S.-based tech company that made only one type of product, portable navigation devices, including the global positioning system (GPS) devices that people kept in their cars at the time. The company was at the top of my short list. To help it keep its shelf space at stores like Best Buy, the company relied heavily on spinning out new models for its navigation devices, with various features or in different colors. Garmin had a strong brand name that allowed it to charge high prices, but my suspicion was that competition would soon push into the segment, bringing prices down. That could trigger a collapse in Garmin’s stock.

By now, I was a seasoned technology investor, enthusiastic about all gadgets and technological devices. I would often go to this Best Buy store in Noho (a neighborhood in New York City north of Houston Street) to check out the latest technology gadgets. On the corner of Houston and Broadway, it sat on prime real estate in one of the priciest shopping neighborhoods in New York. The Noho store was buzzing on the weekends, which provided plenty of material for real-time field research. To get an idea of what consumers thought of a product, I would chat with the shop assistants; compare features, reliability, and prices among different models; and eavesdrop as other customers discussed what they
wanted to purchase. Sometimes I would even jump into their conversations, asking whether they favored certain models over others. This was harder to do by myself than with Andrew. My all-American boyfriend—with his nonthreatening, midwestern manner—always put strangers at ease.

After an hour of this research on Garmin, I decided to conclude my field trip before someone caught on to me and realized my true intention. One salesperson became suspicious when I was grilling him on different models of wireless routers. He thought the product company had sent me to monitor sales in the store. Since then, I only went to that Best Buy on Sunday, his day off.

“Did you learn anything new?” Andrew asked.

I pulled him aside to be discreet. “I’m afraid that the competition is getting tough for Garmin. TomTom and Sony are coming after it aggressively.”

“How do you know?” he said.

I told him that Sony’s latest model cost $200—one-third of Garmin’s—and offered very similar features. The sales guy had also told me that TomTom, Garmin’s European competitor, and Sony in Japan would both introduce more affordable models with virtually the same features in just a few weeks. I believed this competition would be the catalyst for a profitable short play.

Andrew was intrigued by my passion for gadgets like GPS devices. Once out of the store, he told me that my eyes had been shining as I shared my analysis. I told him it was because I had spotted something that the Wall Street analysts glued to their financial models had not yet noticed: Garmin’s sales cycle had peaked. Garmin’s stock also had a price/earnings ratio of 20, far more than that of most technology companies with only one successful device. That’s why I was excited.

“But their latest models look really cool,” Andrew said, reminding me of the slim pink model I had picked up.

“Do you really expect consumers to pay $400 more for a pink device they leave in their car?” I asked him. One tip that Jason had drilled into me was that, in the fast-evolving technology business, hardware companies that depend on spinning out different versions of a single product always get crushed. Dell, Palm, and Nokia had all suffered this same fate: they created products that captivated consumers, but eventually new market entrants created enormous pricing pressure, which in turn killed their profit margins. One could go long on these stocks for a limited window of time, when they were growing their market share. Eventually, however, they all became credible shorts.