What the savviest short-seller has in his sights next

This article is part of Fortune‘s quarterly investment guide for Q2 2021.

Last year, many investors first learned of the name Nathan Anderson and his firm, Hindenburg Research. In spectacular fashion, the tiny investment research shop took down one of the hottest stocks of the 2020 bull market rally: Nikola Corp., an electric-vehicle maker that vowed to do for long-haul trucking what Tesla had done for the humble passenger car.

In a bruising report last September, Hindenburg exposed that Nikola’s prized piece of PR, a widely distributed video showing its rig—the Nikola One semi—cruising across Utah’s high desert, wasn’t quite what it appeared to be. Following Hindenburg’s revelation, the company eventually copped that okay, the prototype Nikola One was not actually built to “drive on its own propulsion.”

The news tanked the stock. Investor lawsuits piled up. Nikola founder Trevor Milton resigned. And the Securities and Exchange Commission opened a probe into Milton and the company to determine whether it had misled investors.

The saga drew investors’ attention to the relatively loosely regulated world of SPACs—the special purpose acquisition companies, or blank-check funding arrangements, that helped bring Nikola and a host of other EV upstarts to the public markets. It also put the spotlight on Anderson and this new generation of activist investors who go about identifying the misdeeds of listed firms in brutally public fashion. The idea isn’t just to name and shame their scalps, but also to profit from their downfall.

These activist investors do so by shorting the companies they target. Corporate boards, SPAC promoters, and day-trading bulls regard Anderson and his kind as the bad guys in an everything-is-awesome bull market. The shorts such as Anderson counter that their whistleblowing efforts are a force for good. They expose possible securities fraud, they argue, and reveal which managers are mere hucksters taking investors for a ride.

For Fortune’s Investor’s Guide 2021 issue, in December, I wrote about the shorts’ tactics, featuring Anderson, Muddy Waters’ Carson Block, and Fraser Perring of Viceroy Research. I caught up with Anderson again recently to get his thoughts about SPACs, cryptocurrencies, and the retail investor phenomenon—and to ask the activist short which areas of the market have piqued his interest.

This edited Q&A has been condensed for space and clarity.

In a bull market like this, one that’s fueled by a frenzy of retail traders, and where the Federal Reserve is padding its balance sheet with billions in financial assets, it sounds crazy to do anything but go long equities. Famously, retail investors who had gone all in on GameStop revolted against shorts earlier this year, inflicting a lot of damage to hedge funds and the legendary activist short Andrew Left. It was around that time when many of your peers put their head down. But you came out firing. In February, you went after a high-flying SPAC IPO, Clover Health. What point were you trying to make?

The need for activist shorts was probably at its peak at that time. We had a market where hundreds of SPACs had gone public, and hundreds of companies were trading at elevated valuations, based purely on a story that appealed to retail investors. It seemed like the insanity was just through the roof. And, we thought, “Okay, this might be an environment where it’s going to be more difficult to make money as an activist short, but the need for it was strong.”

We look at our role as one of holding power to account and taking corrupt companies and executives to task where needed. And at that time it seemed like an ideal market to speak out.

After publishing your report on Clover Health (ticker: CLOV), the stock subsequently nosedived, and the company later revealed the SEC had opened up an investigation. That would seem like “mission accomplished” for an activist short. But you didn’t short Clover Health, and you didn’t pocket from its decline. Do you regret that?

No, not at all. For the moment we were in, we really wanted to take the opportunity to make a point. There was so much attention on the business model of short-selling at the time, that it seemed people were forgetting what is the purpose of critical market research. It was important to just express the whole point of what we do, and why it’s essential for a healthy functioning market. Overall, the feedback on Clover Health has been pretty positive. We did get a lot of people who accused us of being short anyway, which we kind of expected. You know, the market is a messy place. That’s just how it is.

Johnny Milano

Other than SPACs, what else has your attention?

The crypto space. It’s just a real Animal House.

How so?

Within crypto, there are a lot of companies that are suddenly either coming public, or pivoting into crypto—or cryptocurrency-adjacent assets, like building exchanges or buying mining equipment. We’ve done two reports recently on one Chinese company that suddenly pivoted into crypto. Another China-based company we investigated failed to go public twice in Hong Kong due to fraud allegations. It’s also associated with an alleged Ponzi scheme. But then it went public on the Nasdaq instead. And immediately after going public, there were several suspicious bond deals where the IPO proceeds were directed into opaque Cayman-based entities in long-term bonds. Typically, when you take a company public, you use the proceeds to expand your business. But instead, these proceeds just seemed to very quickly go out the door. So we put out that report.

Editor’s note: Here is the report to which Anderson refers. On April 6, Ebang International Holdings responded in a public statement that the Hindenburg report “contain [sic] many errors, unsupported speculations and inaccurate interpretations of events.” It added that the company’s board and audit committee plan “to further review and examine the allegations and misinformation therein and will take whatever necessary and appropriate actions may be required to protect the interest of its shareholders.”

Carson Block of Muddy Waters has been investigating Chinese companies with U.S. listings for over a decade.

Carson is extremely familiar with them. I’ve been reading his work for years. There’s essentially no consequence for an executive who’s running a China-based company to list in the U.S. [If it’s proven that they have conducted] material misrepresentations or misappropriation, or if they’ve lied, the worst-case scenario is their company will get delisted, or charged by regulators. But that’s actually a rare circumstance. So they can just linger for years or decades even, and change the story of the business to whatever the hot topic of the day is—whether it’s crypto or social media back in the day, or electric vehicles. They just raise money and essentially misappropriate it without consequence. That has been going on for quite some time, and there hasn’t been much enforcement from the exchanges. So, occasionally, a China-based U.S.-listed name will pop up on our radar.

Sounds like SPACs too are on your radar.

Yeah, just about every SPAC is a pretty attractive opportunity for us at this point. If there ever was a good SPAC deal, it was probably about 300 SPACs ago. And they’re coming public at a pace of about five per day, or at least that was the case earlier in the year. It’s just been this onslaught of public companies. It will invariably end terribly.

How so?

SPACs are not dissimilar to reverse mergers, which were also considered an inferior avenue to go IPO in that they had a high correlation with fraudulent or promotional companies. SPACs have kind of taken over the spotlight as far as that terrible way to go public. But it’s also a case that there’s just so many of them. Anytime you have this massive supply of companies coming public this quickly, the quality is going to suffer. The types of companies that are coming public are trying to appeal specifically to the retail investor. They talk up a huge TAM—a total addressable market—a trillion-dollar addressable market. These companies come in with little or no financials to say, “Hey, we think we can take 5% or 10% of this market, and dominate it. And you know, we could be worth 100 billion in five years. And here are our projections that show how we get there.” They’re selling a lot of stories.

That could be said of all startups pitching their vision to investors.

[With SPACs] you have these companies that are coming public at these gargantuan valuations. And insiders and promoters are ejecting pretty quickly and leaving the retail investor base saddled with the remaining shares, and whatever’s left of the hope of actually following through on these wild projections. It’s just over and over and over again a disappointment to a lot of the investors who actually hang on for any reasonable period of time. It doesn’t take long for a bad SPAC to implode—usually six to 12 months.

The “pro” argument for the SPAC is that it gives the average Joe retail investor a chance to invest early-stage, just like an accredited investor with deep pockets.

I think the accredited investor rule is outdated. At this point, I don’t think there’s any great reason for that rule. The rule was meant to protect investors from illiquid, early-stage, high-risk type investments. But I mean, you’ve got Dogecoin that has, I think, an $8 billion market cap. [Note: It surpassed $9 billion after we spoke.] It’s a cryptocurrency based on a meme! So any notion that average investors aren’t engaging in incredibly high-risk speculative investing can be safely thrown out the window.

In a venture capital–type investment, the founders and early-stage investors can exit portions of their shares in later-stage rounds. These are all negotiated rounds. Whereas with a SPAC, and a public transaction, that liquidity is pretty much automatic. After the six- or 12-month mark, these insiders can just dump virtually everything—not a dynamic that you see in private markets.

There are risks with investing in any new listing, of course. And still, you see the SPAC as particularly risky to unsophisticated investors?

Yeah. Our focus has always been on identifying and exposing fraud. With these types of SPAC deals, if you catch them early enough, the people that lose the vast majority are the insiders and the promoters, which I think is who should be losing the most.

SPACS are hardly the only part of the market exhibiting bubble-like qualities.

It’s certainly messy. There are a lot of really lousy investments that are floating around that are extraordinarily popular. There’s just a lot of misallocation of economic resources. And there’s a lot of gambling where people are just going all in—and it involves people that can’t necessarily afford to go all in, and lose. And in a period where we’re still struggling with a pandemic. I also recognize the underlying tension that it’s fun for a lot of investors—it’s exciting, and it’s something to pass the time. All that makes for a dangerous combination.

Still, in a bull market, with interest rates near zero, where else would you invest your money?

The most important thing for new investors is to disabuse themselves of these false pillars of security. Just because a company is listed on a major exchange like Nasdaq or the New York Stock Exchange doesn’t mean that they’re telling the truth. Just because a company has an auditor doesn’t mean that the auditor is getting the correct information or the most complete information from management. The kind of things investors often look to as signs of credibility do not provide as much protection as they believe. And that’s important, because the level of scrutiny that should be applied by each investor to these different companies should be quite high. A lot of investors come into it with a comfort saying, “Oh, well, this is a Nasdaq-listed company. It’s got a Big Four auditor. We’ve got a securities regulator that monitors these things, and therefore, we’re good to go.” And that’s not the case.

The thing that really makes or breaks any company is management, regardless of the industry. So whether it’s a good company or a bad company, understand the management. Their background is one of the more critical aspects that people often overlook.

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