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Winning At Short Selling May Not Be A Reason To Celebrate

Our Planet Money team talks to a well-known short seller who tells the story of one stock he bet against. He made a bunch of money, betting against a stock a lot of people liked.

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Transcript

STEVE INSKEEP, HOST:

Our Planet Money team is exploring the world of short selling and short sellers. A short is a bet against something, a bet that the price of a stock will plunge, for example. And not everybody likes short sellers. David Kestenbaum has the story of one short seller who made a lot of money betting against a stock that a lot of people liked.

DAVID KESTENBAUM, BYLINE: One of the tricks to short selling is that you have to find something that everyone else loves - loves too much. And in 2010, a bunch of Chinese companies were getting listed on the U.S. stock exchanges. Investors loved them. China, after all, was booming.

SAHM ADRANGI: One company was a paper manufacturing business; another one made seafood snacks in the Fujian province.

KESTENBAUM: This is Sahm Adrangi. Today, he runs a hedge fund called Kerrisdale Capital. Back then, Sahm was just starting out, and one of the companies, called China Education Alliance, caught his eye. It was like Princeton Review, helping students in China to prep for college entrance exams, which seemed like a winner, but Sahm got a guy he knew who could read Chinese to try out the company's website. And he found something odd.

ADRANGI: What he came back with was he couldn't actually purchase any products, despite the fact that this business generated half of its sales from selling testing on its website. When you tried to go to the part of the website where you would put in your credit card, an error screen popped up.

KESTENBAUM: The company also claimed to have a building filled with classrooms. This was harder to check. The building was in a province in northern China near Russia, but Sahm found someone who lived up there to go check out the building.

ADRANGI: And we asked them to take a camera. So we went there and saw that it was a completely vacant building. When you went to each of the floors, there were six floors. There were no chairs; there were no chalkboards. It was just a completely vacant building.

KESTENBAUM: Sahm knew something the market apparently did not. So he shorted the company - bet over a half million dollars that the stock price would tank. It was remarkably easy to do.

ADRANGI: It's just a matter of pressing the red button instead of the green button on your account.

KESTENBAUM: Was there really just a button - a red button you press?

ADRANGI: It is a red button, yeah. I think it was - or it might say short.

KESTENBAUM: Do you remember how it felt pressing that button?

ADRANGI: Slightly dangerous.

KESTENBAUM: Placing the bet, shorting a company, doesn't do you any good if the stock price keeps going up. So Sahm had to convince the world that he was right, persuade the market that China Education Alliance was not what it seemed. Sahm's team posted a video of the empty building online and wrote up a detailed report.

ADRANGI: And I think we released it on 10 a.m. on November 30, 2010. And within two hours the stock had declined 50 percent.

KESTENBAUM: Sahm made a bunch of money. But he says he didn't really celebrate. When you short something, your profit is everyone else's loss. There were, after all, lots of people who had invested in the company, expecting its stock to go up. Now thanks to Sahm, the stock had collapsed. It felt weird to pop open a bottle of champagne.

ADRANGI: There's a lot of investors that become blindsided when we put out these reports, and we'll say, you know, you invested in a company that was committing fraud and so you should be blaming the management instead of us. But most guys blame us.

KESTENBAUM: This is the argument for short selling. Most investors are looking for the next hot stock to buy. Short selling provides a financial incentive for people to do the opposite - to look for stocks that seem overvalued or worse.

ANDREW LEFT: People always said, why did no one ever discover Bernie Madoff?

KESTENBAUM: This is Andrew Left, another well known short seller.

LEFT: The reason why is because you couldn't short Bernie Madoff. Trust me, if there was a way to short Bernie Madoff, he would've been found out 15 years ago.

KESTENBAUM: Andrew Left thinks we're wired to be over-optimistic, which is a nice thing, but it can get you into trouble. David Kestenbaum, NPR News. Transcript provided by NPR, Copyright NPR.

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