Friday, 25 January 2013

Herbalife - bet sizing

I don't have much to add that hasn't been said already better by other bloggers and media outlets.

to summarize;
1) Bill Ackman is short ~20mm shares (#113mm shares outstanding) ie 17.7% of the company at current price of $45 that is a $900mm short.
2) Dan Loeb is long about 8.9mm shares.
3) John Hempton was (I don't know if he still is) long shares. He's done some digging on Ackman's short thesis. (bronte capital commentary)
4) One suspects that Icahn is long.

I've read most the the secondary commentary on the stock and have done no work on it on my own. Ackman's short thesis should be on the web, I've linked to Hempton's comments which I think work well as a rebuttal. Loeb's description can be found in Third Point's investor letter from last quarter.

The major point I wanted to make one of appropriate "bet sizing".

I believe Pershing Square (PSCM) has an AUM of ~$9bn.

Shorting $900mm of a stock, ie 10% of AUM is just too big. Way too big.

Shorting 18% of a company is too big a position.

I guess they have sized this position based on number of days volume, because on this metric (looking back) it is 10days volume.

That is terrible, naive risk management.

Being short is a different risk profile to being long, and being publicly short increases the risk.

Icahn, although rude, is right, what is Ackman going to do if there is a short squeeze, or if the company starts to use FCF to buy back shares??

Conservatively the volatility on the stock is 50%, it is not hard to see it moving up ~30% in a month to $60. That is a $300mm loss.

~3% of aum.

But then you haven't even started trying to get out of your position, which you are likely going to have to at that point. I think the slippage on trying to get out is going to be horrific. I wouldn't be surprised if it was 5-10%.

This is the sort of position that would give me ulcers. This size trade is the sort that you can lose your company and name with when it goes very badly wrong.

Volkswagen shares traded as high as €1000 during their short squeeze in 2008 ie a squeeze of 600%. PSCM would have been liquidated long before it got close to that.

Even if he was proved to be eventually right, there are many potential paths where he loses hundreds of millions of dollars and gets stopped out. Personally I would never want a short to be more than 2.5% of AUM. In fact I'd much prefer to bet on something like this shorting credit or buying options, where one's downside is fixed and limited.