Who is Citron Research?

Citron Research was arguably the most well-known activist short-selling firm, with Andrew Left at the helm.

Citron is known for their highly publicized bearish research reports, which they publicly released online. Citron has been in the short-selling game for twenty years, since its start in 2001 as StockLemon. 

On the morning of January 29, 2021, Andrew Left announced that Citron Research is no longer releasing bearish reports and instead will focus their public efforts exclusively on the long side.

The decision is almost certainly inspired by the recent Gamestop (GME) short squeeze, in which Left’s hedge fund, Citron Capital, was caught short.

Left’s biggest specialty was finding outright fraudulent companies, firms that mislead investors, or overvalued/overhyped valuation plays.

He identifies these through a mix of fundamental analysis, sentiment, and general market structure factors like short interest, float, or the type of investors in a company’s shareholder base. 

When Left identifies a good short opportunity, he doesn’t just short the stock or buy some puts.

He lets the entire market know that he’s short by publishing a research report detailing his thesis and appearing on financial media to explain his report’s findings. 

And his reports move markets.

It’s not unusual for one of Left’s shorts to decline 20% or more on the day the report is released. As a result, he has a mixed reputation.

Many shareholders of his picks get mad that their stock randomly took a nosedive intraday, while several of his targets have sued him. Left claims that he’s never lost a lawsuit in the US, and as a result, the lawsuits have slowed in recent years.

Left’s reports read like cocktail talk more than your traditional buttoned-up equity research report. He frequently curses, makes jokes, and doesn’t shy away from making very bold statements about management teams.

As such, his reports are closely followed by even the most casual of individual investors. They’re easy to understand. He doesn’t get caught up in financial jargon and instead cuts through to the main idea. 

For example, his appearance on CNBC’s Halftime Report explains his short thesis on cannabis firm Tilray (TLRY). He didn’t launch into a spiel about price-to-sales ratios, margins, average sale price, etc.

Left simply lambasted the idea of owning the stock and refused to treat the company seriously. His pitch was simple. He thought the price was high because of the tight float and that Canada is a horrible place to grow cannabis profitably. 

https://www.youtube.com/watch?v=uSEW5ZtDumQ

How Andrew Left Got Into Short Selling

Like most well-known gen-X investors, Left really got his start during the dot-com bubble, although he had been trading since the early 1990s.

But, instead of making boatloads of money buying Yahoo and Cisco (CSCO) like Mark Minervini, Left actually focused on the short side. In a podcast interview, he recalled his first big trade, which was shorting the book distributor Books-A-Million in 1999.

The stock went from $15 to $60 in four hours, and Left was shorting the stock on the way up. He quickly got a margin call from his broker before the market closed for the weekend. “I spent the whole weekend just s**tting my pants,” he said. 

Lucky for him, the stock bailed him out on the following Monday, reaching just a point below his average price of about $38, minting him around $50,000. He says this was one of the only times he was terrified while in a position.

In a typical fashion for these types of scare trades, the stock declined to $21 just days later. 

Left continued to favor the short side, even after this experience, and built out a niche shorting inflated stocks during the dot-com bubble. Amazingly, he found success throughout the bubble, rather than suffering through losses only to see one massive win as the bubble burst.

Citron Halts Public Short Selling Research

Amid the Gamestop (GME) short squeeze, Left announced on YouTube that he’d no longer be providing public research on short selling.

Here’s Left’s statement:

Hi everyone, it’s Andrew Left at Citron Research. Twenty years ago, I started Citron with the intention of protecting the individual against Wall Street, against the frauds and the stock promotions that are just all over. When I started it, everyone used to say, ‘can you just write whatever you want to write online? And not be a registered brokerage firm, and not be Merrill Lynch at the time?’ I said ‘sure, it’s freedom of speech in this country and if I’m telling the truth, I’m just gonna write it.’ And for the first 15 years of its existence, not CNBC or the Wall Street Journal even wanted to note the fact that we existed. Even while we uncovered more fraud than any non-governmental agency out there. We helped bring down the drug pricing in this country against the better interest of the hedge funds. And we’re proud of the work that we’ve done. But now, after twenty years, we noticed something. When we started Citron, it was supposed to be against the establishment, we’ve actually become the establishment. We’ve done this whole thing without ever hiding from lawsuits, without ever hiding behind a pseudonym. But, it’s completely now lost its focus. So as of today, Citron Research will no longer be publishing what can be considered as short selling reports. The Citron narrative is going to change and have a pivot. What gets lost in the whole Citron Research world is the fact that the performance of the Citron Fund and Citron Research on our long recommendations was up 121% average from recommendation to the high point of the stock. That was in 2020. We want to bring investors stocks that they can make five, or ten times their money on. But, at the same time, have strong management teams, ethical business practices, business models that are forward-thinking, socially conscious. And we’re gonna bring them to the individuals. These companies can use the support of a whole new generation of shareholders that have an appetite to buy stocks. If you choose to buy Gamestop here, it’s caveat emptor. You know what we think about their business model, it’s on you, too much has already been written. But until then, we will have our first story ready on Monday. We want everyone to breath, smile, we’re excited for the next ten, twenty years of Citron. Hopefully we can use our experience to add some sanity, and most of all, some kindness to this market. Cautious investing to all, and have a great weekend. 

While this indeed came as a surprise, Left had been shifting to the long side for a few years at this point while still maintaining a short book.

In 2019, he promised investors in his hedge fund Citron Capital that he would stop shorting any “story stock” or similar names without control momentum. He also highlighted how well his long investments treated him in his 2020 investor letter, which was just published a few weeks ago.

When reading Left’s annual fund letters or listening to interviews, he sees himself as a practical investor and trader.

He doesn’t care about being right or having a fancy answer to the market’s questions.

When talking to Carson Block about his shift towards the long side, especially after the March 2020 crash, he said, “My investors don’t pay me to be right. My investors pay me to make money. I’m not a professor. I’m not supposed to have some erudite answer about the Fed and its effect on the monetary flow. Make money. That’s my directive for my investors.”

In the interview, he also told Block that he thought short selling was a bad investment strategy for most. 

Perhaps Left’s losses on the Gamestop (GME) short lead him to conclude that short selling in this market environment isn’t practical.

After the March 2020 downturn, he said he started looking for the easier money, buying shares of solid consumer product companies that would benefit during lockdowns.

As successful as Left’s short-selling career has been, short selling equities as a primary strategy arguably has little going for it. Consider these frictions that act against short selling’s profitability: 

• You can only gain 100% in the best-case scenario.
• Your risk is unlimited.
• You typically have to pay an interest rate to borrow the shares.
• Sometimes you can’t even locate shares for a stock you want to short.
• Your borrowed shares could be called due at any time.
• The stock market has an upward drift, bringing all stocks with it. You have to essentially earn the market return just to break even when short selling.
• If you have a big enough position, you could be caught in a short squeeze, as we all saw in several stocks in the week of January 25, 2021.

To highlight just how difficult short selling is, consider that Jim Chanos, arguably the best short seller in modern times, still loses money on his short book.

That’s right: the guy whom Institutional Investor called the “LeBron James of short selling” still loses money on his shorts.

Chanos instead views a robust short book as a market hedge that allows you to take more risk on the long side and significantly boost your absolute returns, rather than a way to profit outright.

His hedge fund Kynikos, which remains 190% long and 90% short, has an average annual return of 28% since its start in 1985. 

Left employs a similar long/short tactic in his hedge fund to Chanos, except Left is selective with both his longs and shorts, while Chanos uses index funds for long exposure.

Is Activist Short Selling Over?

From the outside looking in, activist short selling might seem to have little downside. Activists release their research, and if it’s good, traders and investors will sell the stock and push the price down.

Activists get a quick win with a fantastic IRR, and if the information is accurate, the market becomes more efficient. 

Activist short sellers are beginning to realize that this can play against them, though. They’re tipping their hand to the entire market, betting that their cards are stronger than their opponents, without even seeing their opponent’s cards.

Most of the time, their research and industry respect win out.

Besides, sometimes the market doesn’t listen to activist short-sellers.

One of Citron’s recent high conviction ideas was a Chinese education company called GSX Techedu (GSX), which Left confidently maintained was worth very little if not zero.

While there was some short-term bearish price action around the release of his report, the market quickly shrugged it off and sent GSX off to new highs. 

 

This GameStop (GME) situation is different, though. The stock had a short interest north of 100% for years. Many traders have been buying breakouts in GME, hoping for a squeeze for years.

But there was never a catalyst to generate enough buying interest to get the shorts to cover. Then Citron Research announced on January 19 that they were bearish on Gamestop and were going to release a report the following day. 

At this point, the GME short squeeze was already underway, but the stock was only at around $40 compared to the $400+ highs seen in the following week. 

We all know what came next.

Reddit’s WallStreetBets noticed the relatively tight float coupled with the very high short interest, and the trade idea went viral. GME went parabolic, and the stock’s ultimate fate is still unknown.

We have to remember the unique nature of Gamestop (GME). The short interest was north of 100%, coupled with a not-so-large share float. Such a high short interest is quite rare and will probably be extinct once the funds stuck these shorts can liquidate.

Did the recent short squeeze mania push some out of the activist short-selling game, and perhaps shorting altogether? Sure.

The herd has sure thinned and we probably won’t see any activist short reports for a while.

Each time a door closes, a new one opens.

Many shorts that were previously attractive but too crowded may present enticing entry points to those shorts that weathered this storm. Just as long-only funds catch amazing deals during previous liquidity crunches like 2008, those short-biased funds that survived are handed opportunities. 

The most recent notable activist short report from Hindenburg Research is telling. The report details Hindenburg’s lengthy investigation into health tech firm Clover Health (CLOV).

The telling part, though, is that Hindenburg didn’t have any position in CLOV when they published the report. 

Track Record and Returns

In 2018, Andrew Left announced that he was raising capital for a small hedge fund, Citron Capital.

According to Institutional Investor, he raised no more than $250 million, primarily from family offices.

Contrary to what you may expect, Citron Capital isn’t largely net short, as evidenced by their investor letters. In 2019, the fund’s average exposure was 75.8% long and 80.3% short, leaving an insignificant net short positioning throughout the year.

They were even net long throughout 2020, with an average long exposure of 98% long compared to 78% short.

The fund’s net returns (returns less management and performance fees) since inception are 43% in 2019, and 155% in 2020.

Beyond just greatly outperforming the index both years, he did it with relatively low net exposure.

Prior to Left opening his fund, it was impossible to know what his returns were, as we couldn’t know when he was entering and exiting if he utilized derivatives, etc.

However, the Wall Street Journal studied his short picks and found that his public short-selling targets declined an average of 42% a year after the release of the reports. 

Bottom Line

With Citron out of the activist short-selling game, their public profile is bound to decline. After all, market-moving short reports are rare, and the financial press loves reporting on them.

Buy recommendations, on the other hand, are a dime-a-dozen. Just look at your newsfeed during premarket; dozens of them are issued every morning.

Citron’s newest pick post-GameStop is Conversion Labs, a telemedicine play, announced on their Twitter on Monday, February 1, 2021.