The effects of short selling on company valuation
Recently, three major Swedish listed companies have been hit by a phenomenon known as short selling attacks. Most recently, Truecaller was subjected to such an attack when Viceroy Research published a report on alleged tax fraud and GDPR violations. One of the consequences of this was that the share price fell by several percentage points during the day.
Despite the increasing number of European companies being subject to large-scale coordinated short selling attacks, the phenomenon remains relatively rare. Smaller-scale short selling, on the other hand, is something that most listed companies are already grappling with. Here we offer some advice on how to approach the problem most effectively.
What is short selling?
Short-selling is a phenomenon where investors bet money on a stock price moving down. This is done by an investor borrowing a share and selling it, in exchange for a promise to buy and return it later. The hope is that the price of the stock will go down so that the investor makes a profit, which is the difference in price. In this way, large profits can be made. At the same time, the investor takes on a huge risk - the price of the stock can only go down to zero, but it can climb up indefinitely. No matter the price, a short seller will have to buy the stock back after a certain period of time. This can result in large losses if the value of the stock rises significantly.
What effect does short selling have on companies?
When many investors short a particular stock, it is seen as a warning sign, which is not surprising as it indicates an expected price decline. These decisions are often based on an already deteriorating share price, poorer performance or suspicions of wrongdoing such as misleading reporting. With a large proportion of shares shorted, negative information is incorporated into the share price, leading to price deterioration. This, in turn, can attract media attention, which can further exacerbate the share price crash.
Shareholders are not the only ones affected, but the company may also be facing problems in the future. If there is mistrust of the valuation, it may be more difficult for the company to obtain bank loans and interest rates will often be higher. The possibility of raising capital is also reduced when the share price falls. In addition, mistrust can spill over to other stakeholders, which can further create problems from a public relations perspective.
How can short sellers be countered in the most effective way?
The single measure that bites hardest against short sellers is to ensure transparency. This removes the uncertainty that underlies a valuation. So invest in detailed investor relations work. Express confidence in the company's ability to create value over time. Whatever you do, don't shut out investors who have shorted their shares. This can make the situation more difficult, as it gives the impression that you are hiding something. As short sellers are particularly vulnerable to mistrust, it is important that the company's management is seen as credible. Even negative information should be published, even though the share price is likely to fall as a result. It is better that the company maintains control and communicates the negative information rather than anonymous short sellers pushing down the share price.
There also needs to be forums for investors and companies to meet and have questions answered. Investor presentations, capital markets days, roadshows and quarterly presentations are all good forms of IR activities. Research suggests that an investor website is the single most important element in investor relations. So make sure you have accurate and relevant information published here.
Seven points to discourage short selling:
Be proactive in your communication.
Invest in IR.
Create meeting forums for investors.
Invest in the IR web.
Don't lie, don't ignore.
Have an active dialogue.