The most prominent short-seller targeting Canadian stocks has set his sights on a company that's fought off the bears in the past, setting up what could be a protracted showdown.
The short-seller is Marc Cohodes, who has previously targeted Home Capital Group among half a dozen other TSX-listed companies. And the target is Exchange Income Corp., the Winnipeg-based industrial dividend machine that has so far successfully defended against the allegation that its payouts are unsustainable.
Mr. Cohodes revealed his Exchange Income short on Wednesday, accompanied by a presentation called Mayday EIF dividend. The shares, already sharply lower this year after a first-quarter earnings miss, fell nearly 10 per cent in early trading before closing at $31.10, a 4.7-per-cent decline from Tuesday's close.
The company quickly responded, calling it a "short and distort" campaign, and says Mr. Cohodes' report "is based on a number of statements, assumptions and opinions with which we strenuously disagree."
The company says its "consistent strategy since its inception in 2004 … has enabled us to grow profitably and return a reliable and growing dividend to our shareholders." The company complained that the short report came out while it was in a "quiet period," and it says it would move up its second-quarter earnings release from August to later in July to more fully respond.
A core element of Mr. Cohodes' argument should be familiar: Exchange Income stock plummeted in August, 2014, when I shared the views of Veritas Investment Research that the company's dividend, and its very health, was in jeopardy because of the performance of its U.S. cellphone-tower unit. Exchange Income surprised the markets two months later by selling the business unit and plowing the money into the purchase of a regional airline, adding to its aviation business. Solid results and an increasing dividend allowed Exchange Income's shares to triple over the next two-plus years. (Veritas dropped coverage of Exchange Income in November 2015, saying the key issues it identified "are no longer material to the Company's valuation.")
However, I have never retracted my view of the company's performance; when you take the company's cash flow and capital expenses, as calculated and reported according to International Financial Reporting Standards, the company has never consistently made enough money to pay its dividend. That was true at the close of 2015, when I last wrote about the company, and it was true in 2016, and it was true in 2017's first quarter.
Exchange Income CEO Mike Pyle, who is an aggressive defender of his company, told me last year that my opinion is "a profound misunderstanding of cash flow." The company's capital expenditures represent "investing in growth. … It's akin to a retail chain opening 1,000 new stores, but it can't pay for them out of existing cash flow. Somehow that's a problem? No, you're growing … the test of whether this is growth capex is whether we're growing, and it's unequivocal."
Mr. Pyle now has a far more challenging opponent than me. Mr. Cohodes makes the same point about the cash flow ("EIF has never been able to afford its dividend. Will it ever?") but he has upped the ante, asking whether Exchange Income's lack of maintenance capital expenditures have led to fatal air crashes and poor, expensive service to Canada's Indigenous communities.
Mr. Cohodes has also flagged questions about the resumes and backgrounds of the executives at some of Exchange Income's aviation subsidiaries, and suggested an affiliate of one of the companies is run out of a Connecticut liquor store. He also calls Exchange Income's Regional One subsidiary, an aircraft parts distributor and leasing company that generates one-third of the company's profits, as a "chop shop" that doesn't deserve its implied valuation.
The bare-knuckled tactics are par for the course for Mr. Cohodes, who is shorting Valeant Pharmaceuticals International Inc., Concordia International Corp., Intertain Group Ltd., Equitable Group Inc., Badger Daylighting Ltd., and Home Capital. His recent Canadian initiatives come as a personal venture with family money, as opposed to a long career running a hedge fund that tangled with many prominent names, including Lernout & Hauspie Speech Products NV, which was ultimately revealed a fraud, and Novastar Mortgage Inc., a subprime lender that collapsed in the U.S. financial crisis, earning Mr. Cohodes a Harvard Business School case study.
In an interview Wednesday morning, Mr. Cohodes says he's not targeting Canada. "I go where the fleas are. It has nothing to do with the country."
At the same time, however, he's happy to say the lack of a national securities regulator in Canada is one factor in creating an environment that is ripe for targets. Many Canadians see Mr. Cohodes as part of a broad us-versus-them battle, in which nefarious American short-selling cabals are ganging up on Canadians. Yet there needs to be more introspection, says Jerome Hass of Lightwater Partners, a fund that shorted Exchange Income in 2014 and Home Capital not long after. (Both short positions are now closed, Mr. Hass says.)
"The discussion always seems to be couched in nationalistic terms, but it shouldn't," Mr. Hass says. "It points out the inefficiency of the Canadian market, and there are a lot of opportunities because of it."
The hedge-fund community is "tiny" in Canada, versus the U.S., where some firms are seeing roughly half their trading commissions coming from hedge funds. "If you're an analyst or broker [in Canada] you have very little incentive to develop a short thesis on a stock, because at least 85 per cent of the brokerage business is probably with bank-owned brokerages, and if you do, that will be immediately be kiboshed by the investment bankers, the commercial lenders and everyone else in the organization, because every issuer is viewed to be a potential client of the broader bank," Mr. Hass says. In the U.S., "if half my commission revenue is coming from [hedge funds], I'm going to pay a lot more attention to short theses and make sure my analysts develop a skill set to identify them."
And Mr. Hass agrees with Mr. Cohodes about the need for a national regulator. "It's something a lot of Canadians don't get. I spent the bulk of my career outside of Canada, and the perception of Canada and Canadian capital markets is very different than Canadians' perception of it. We have a very inflated view of ourselves."
What is inflated can also be deflated. Exchange Income will now try to keep Mr. Cohodes from letting the air out of its shares. Stay tuned for a lengthy battle.