Muddy Waters founder Carson Block talks with P&I on what he's shorting

High-profile investor Carson Block is a member of a very small club – activist short sellers.

On Wall Street, short sellers are often ridiculed or simply reviled.

But Carson Block and the firm he founded, Muddy Waters Research, represent the kind of fundamental analysis that only a few will undertake. After taking an activist short position in Chinese companies such as Sino-Forest, Mr. Block's gone global, taking on U.S. and European companies. He publishes Muddy Waters' research on his positions to the wider investment world.

On Monday, Jennifer Ablan, editor-in-chief of Pensions & Investments, conducted a wide-ranging interview with Mr. Block about the best shorts of his career, how today's sell-off has changed his niche of the market, his views on cybersecurity and information leakage.

Broadcast on Twitter Spaces, the Q&A has been edited for length and clarity.

A: There are a lot of misconceptions about what we as activist short sellers do. We are a niche of a niche. In traditional, non-activist short selling, the goal there is to generate alpha.

The goal with activist short selling is to generate returns. What we're doing is important to understand: almost everything we do as activist short sellers is looking backwards.

We're asking three questions: Is the information the company disseminated materially correct? Has the company told a lie of commission? Has the company lied by omission? Does the market accurately understand the information the company's put out?

If material information is highly misleading or an outright lie or not all out there, there can be something for activist short sellers to do. We make sure the market knows what we know. These companies, pre-financial crisis, they could be good shorts. But in a traditional model, nobody was really telling that. We'd get the media interested in writing articles. After the financial crisis, and QE infinity, those shorts became really bad shorts, unless you were telling the world about them. Even when you did, they can still be horrific shorts, like Wirecard. It went up for years, before it finally went down.

Are we macro? No. Thematic? Only in the rearview mirror.

I started this business because when I was in China, I came across a company listed in the U.S. that was a fraud, exposed it, and it went viral. I learned it was systemic, and China became the theme inadvertently.

A few months ago, I realized we were doing a lot in the green tech space. And others had as well. It made sense.

It's an area that's really hot. People feel compelled to buy it, with passive flows. In the post-GFC environment, the grifters come out in force to grab that money.

A: To be clear, with Sunrun, we're not accusing it of conduct that's necessarily illegal. There could be tax fraud. But that requires a legal determination. If something's a fraud, it's about whether you can get a conviction. We don't come out and call companies frauds, unless it's obvious, like in China.

When you look at Sunrun, (it's) highly aggressive and misleading on the tax incentive side. Even if the IRS doesn't say it's fraud, the problem Sunrun has it's they won't buy the tax basis models anymore. The way they spin investors is not illegal. We hang on the edges of our seats to hear these non-GAAP numbers companies give us. They say they're estimates, and assume a 5% discount rate on cash flows going out 20 years in the future. Now it's clearly absurd.

A: It's important to say I believe in global warming, it's caused by human activity. I want to see something done about it. But when a lot of people, both institutional and retail, and (their) impulse is they want to hug a solar panel because it will save the world. A lot of this is grift. Solar is a real technology. I don't have antipathy towards solar, but from investment perspective these are egregious misrepresentations of economic reality, and possibly tax fraud.

To the extent the company has obtained tax equity financing, it was by grievously misleading the IRS. That's the problem.

It's emblematic. If ESG is your pet issue, you're not going to ask questions.

Like, what is the carbon savings from a solar panel that's produced in China with coal-fired power, labor issues, and put on a diesel-powered boat to the States? The answer might be solar is still a great trade-off. But those conversations haven't occurred.

What we see around the green-tech and sustainable investing is a microcosm of societal dysfunction.

A: It's not often a company says 'yeah, we're snowing everybody.' What are they going to say? Of course they deny it. In terms of substantive content, we asked some basic questions. Fine, you're not screwing the U.S. government. Then release your tax basis for projects you've securitized … over the past few years. Pretty simple. Just tell us what it is on a per-watt basis. You sell to homeowners at $3 a watt. I may claim the tax credit at $3 a watt.

But when the company goes to the IRS, they say it's $5 a watt. What's false about what we've put forth? It's largely non-substantive response. We are still short Sunrun.

A: Ok. I should disclose our AI told us to cover Hannon a week ago. I want to make clear that was our AI we developed. There was internal dissent here as to whether we should cover it. It will be interesting to see whether our human logic ends up being better than our AI.

Hannon Armstrong provide mezzanine financing in a lot of solar farms, wind farm projects. The issue is the accounting. Because of the way tax subsidies was enacted by Congress, the partnership accounting can be really complex.

Hannon booked income that's phantom income. It's never going to turn into cash, and it's not realizable income. In doing that, they papered over what we think are a lot of value-destructive, awful investments in their book. They make loans to projects that were already PIK-ing, issuing payable-in-kind notes on its prior loans to the project. That's generally a really bad sign.

Hannon could clarify this. They won't come out and say. They issued fire-and-brimstone response. They've not provided anything substantive to rebut what we're saying.

A: We've been public on shorting Danimer Scientific, which was a bioplastics SPAC. We publicly shorted that last September. We're short some other names that other activists have published on, but I'm not able to disclose which names.

Most of the time a short thesis is going to be realized because of economic impact. If you can break through and the market understands this, then it's a viable short thesis.

A: What we do brings a lot of untrustworthy people out of the woodwork. I do behavioral interviews, with polygraphers and CIA. We look for inconsistencies.

With counterparties, we tell them all, we want as few people touching our orders as possible. The whole desk doesn't see what we're doing.

The person on the other side has an asymmetry to screwing us.

A: On a day-to-day basis, information leakage. I have a lot of frustrations as the principal of a fully SEC registered investment adviser.

When it comes to cybersecurity, SEC has taken it seriously. It's a checklist-driven world. We knew when we launched that if we wanted the best cybersecurity that we could afford, we should home grow what we're doing.

We're so outside the box for the SEC, with the strategy, it's just one more thing they could write us a speeding ticket on. Years ago, we decided to go with an industry standard vendor who knows how to fill out the SEC checklist and questionnaire.

You can never be completely safe. We've been the target of state-sponsored hacking, particularly by the Chinese. That's not just because we're a threat to the state. They do this to everybody of interest. State-sponsored hackers have a 90%-plus success rate at penetrating networks. We have to be realistic.

A: Burford Capital. It's a listed litigation finance company with highly aggressive accounting. Their asset class is so esoteric. The CFO had been the CEO's wife. It was disclosed but no one knew it. It got really personal with us in a way that was sloppy. (Then CEO) Chris Bogart went onto CNBC after I'd been on.

He was trying to pretend that he wasn't on to respond to me. But he said something like, 'I don't have time for Carson Block and his new friend Stormy Daniels.' When you try to slut shame her and me on the same day, I enjoy that. The stock went down a lot.

A: We just this year hired someone to handle marketing. We were the world's worst marketers. We've stopped laughing and tried to do something. We usually get referrals.

We get inbounds for people introducing us through prime brokers. We are only slightly inversely correlated, that's one thing that complicates the sales process. People don't understand what we do is very different from traditional short selling to generate alpha.

Activist short selling is very capacity constrained. We could never get up to $1 billion in AUM. If we did that, we'd be doing clients a tremendous disservice.

The trades aren't that big. Sometimes they can accommodate $100 million or $200 million. But our bread and butter trades are $10 million to $50 million for the vast majority. There's a small tier of us (doing) north of $50 million, and mostly less than $100 million.