Hacktivist-affiliated Anonymous Analytics just released a new research report: a high conviction buy recommendation on Demand Media (DMD). In a statement made to Integrity Research, Anonymous Analytics says it is “trying to find our boundaries” as it tests whether the Muddy Waters business model of profiting from positions taken before a report’s release works as well for long positions as it does for shorts.
Demand Media is an under-followed small cap stock with a current market value of $400 million. According to Thomson Reuters First Call, it is followed by 6 sell-side brokers, and the average rating is ‘Hold’. Analysts following DMD have generally given up on the stock since Google changed its search algorithm to thwart DMD’s initial strategy of generating low-cost (and low-quality) content geared to gaining high search rankings.
Anonymous Analytics argues Wall Street is overlooking improvements in DMD’s fundamentals and external catalysts to growth. Consistent with its past reports, the new 34-page analysis is well-researched and thorough. It makes the case that DMD will profit from a new ICANN program to expand domain name extensions and cites web statistics suggesting that DMD has turned around its content strategy in the wake of Google’s smackdown.
Muddy Waters Business Model
Taking a position in a stock before you issue a report is a business model adopted by a handful of firms, Muddy Waters perhaps being the best known. However the model should rightly be called the Andrew Left business model, since the founder of Citron Research (formerly StockLemon.com) pioneered the approach in 2001.
The model can be lucrative. Former Muddy Waters contributor Jon Carnes, who subsequently started his own website www.AlfredLittle.com, has claimed that he and his contributors made about $10 million shorting Chinese companies.
The downside is increased risk of lawsuits and regulatory actions. Canadian regulators accused Carnes of producing a fraudulent report on Silvercorp Metals Inc. (SVM) and one of Carnes’ researchers was jailed by Chinese authorities (who allegedly were assisted in their investigations by Silvercorp). Andrew Left of Citron has been the subject of numerous lawsuits and was disbarred for three years by the National Futures Association for allegedly having made ‘false and misleading statements’.
But then again, any short-oriented researcher risks the legal wrath of its subjects, as Gradient Analytics (née Camelback Research) found when sued by Overstock and Biovail.
Shorts v. Longs
According to its disclaimer, Anonymous Analytics itself holds no direct or indirect interest or position in Demand Media. The disclaimer also says:
“However, you should assume that certain contributors to this report, as well as their members, partners, affiliates, colleagues, employees, consultants, muppets clients and investors, as well as our clients have a long position in the stock or debt of Demand Media (“DMD” or “the Company”) and/or options of the stock, and therefore stand to gain substantially in the event that the price of the stock increases.”
As Anonymous Analytics suggested in a statement made to Integrity Research “This report is more of an experiment to see if anyone cares about long ideas coming from us.” Short ideas are attention-grabbing and controversial, making them more media-friendly. Good news is an oxymoron, hence, other than this obscure blog, you are unlikely to see much written about its DMD call.
Similarly, the market impact on DMD is likely to be more muted. DMD closed up 2.8% after Anonymous Analytics’ report was released. In contrast, short calls often have immediate double-digit impacts.
In its statement to Integrity, Anonymous Analytics indicated that short ideas are stressful: “Most people don’t appreciate the time, resources and emotional fatigue that go into a fraud report. If you’re calling a company out as a fraud, you need to come correct – there is no room for error. It’s challenging and there are lulz to be had, but the pressure can also be soul-sucking.”
Acquiring Information through Unconventional Means
We also asked Anonymous Analytics about its tagline, inquiring about the ‘unconventional means’ it uses to acquire information. Anonymous Analytics insists in its disclaimer that all information used in its reports is publicly available. It defines ‘unconventional means’ as more thorough due diligence than is typically practiced by Wall Street analysts:
“So, Sino-forest was taken down entirely on public information. But just because something is legally defined as public information does not mean it’s public knowledge or it’s easy to access. SAIC filings, web traffic, daily number of trucks leaving a manufacturing plant –technically this is all public info, but very few people can or have the ability to get it and/or interpret the data in a meaningful way. That’s the type of stuff we specialize in, and it’s very different from the traditional sell-side research we’ve all come to know and love.”
Investment research is a tough business, largely subsidized by client commissions. It is hard to differentiate your research from the crowd, hard to get in front of clients, hard to get paid. For a handful of research firms, the so-called Muddy Waters business model is a viable option, albeit fraught with legal risks.
What is interesting is the application of this model to long ideas: lower legal risk but will the rewards be there? If so, the business model may be one more approach to filling the void in small cap stock coverage we discussed yesterday.
Nevertheless, don’t assume Anonymous Analytics has given up on short ideas. Their last words to us: “But don’t worry – we still got a lot of frauds left to blow up.”