The SportsFolio Journal - June 19, 2021
The New Short: DraftKings
Just last week, we were discussing shorting. Then, this happened:
On its website, Hindenburg Research describes itself as follows:
Founded by Nate Anderson, CFA, CAIA, Hindenburg Research specializes in forensic financial research. Our experience in the investment management industry spans decades, with a historical focus on equity, credit, and derivatives analysis.
While we use fundamental analysis to aid our investment decision-making, we believe the most impactful research results from uncovering hard-to-find information from atypical sources. In particular we often look for situations where companies may have any combination of:
Bad actors in management or key service provider roles
Undisclosed related-party transactions
Illegal/unethical business or financial reporting practices
Undisclosed regulatory, product, or financial issues
Their Twitter handle description is shorter and more colorful:
Popping bubbles as we see them. We express strong opinions. Not investment advice.
Hindenburg released a detailed report on Nikola, the electric truck company, back in September 2020. We actually covered it in the October 2020 issue of the SportsFolio Journal (back then we were writing monthly). Among other things, Hindenburg uncovered that the Nikola video where the truck was moving was actually nothing but somebody pushing the truck down the hill and filming it!
There will be a lot to discuss on this, but to us, it all crystallizes in a single video: Nikola One in Motion.
Hindenburg Research uncovered (among many other things) that “Nikola had the truck towed to the top of a hill on a remote stretch of road and simply filmed it rolling down the hill.” You heard that right: the truck was rolled down the hill! Nikola’s response: "Nikola never stated its truck was driving under its own propulsion in the video."
That, right there, is the problem. The truth is not just a literal recitation of facts. The truth requires context. While Nikola may have never said that the truck was driving under its own propulsion, that’s what a reasonable person would believe and that type of spin-doctoring is simply not acceptable. As a society, we absolutely have to get past corporate greed, start acting in accordance with values such as truth, honesty, transparency and honor, insist that others act the same way and put the long term over the short term. That is the only true recipe for success and if we continue to take shortcuts, it will catch up to us eventually. It may take a while, but the cows always come home.
Hindenburg’s latest high-profile write-up is DraftKings. The allegations are sensational. Among other things, Hindenburg alleges:
Unbeknownst to investors, DraftKings’ merger with SBTech also brings exposure to extensive dealings in black-market gaming, money laundering and organized crime.
We estimate that roughly 50% of SBTech’s revenue continues to come from markets where gambling is banned, based on an analysis of DraftKings’ SEC filings, conversations with former employees, and supporting documents.
We think DraftKings has systematically skirted the law and taken elaborate steps to obfuscate its black market operations. These violations appear to be continuing to this day, all while insiders aggressively cash out amidst the market froth.
We are obviously not in a position to sort through what is true and what is not, however it seems well-researched. In any event, in our view, any legal issues related to this simply adds to the shaky legal ground DraftKings sits on from a product perspective. We have long maintained that its fantasy sports operations are simply unregulated claims on sports performance, and thus, fall under the CFTC jurisdiction. One CFTC commissioner actually went public with his views that football is a commodity implying that CFTC has jurisdiction, which we wrote about in our April 1, 2021 issue. If you are into technical stuff, you can also start with our Supreme Court amicus brief (.pdf here) and our comment letter to the CFTC.
Even if the CFTC does not want to take jurisdiction, there are state laws. If fantasy sports was a game, it would have been one thing, but it’s not a game. (Curious why?) Looking at DraftKings through that lens, the state laws all of a sudden start to look less accommodating.
Finally, there is this 60-year old law, called the Wire Act. The Wire Act is not going anywhere and it was recently confirmed that it applies to sports gambling. Even if potential CFTC jurisdiction is not an issue and even if the state laws are as accommodating as DraftKings believes them to be (those are two big IFs), mobile sports gambling and the Wire Act simply don’t work together.
Admittedly, our views have not gained widespread acceptance yet, but we’ll keep raising awareness around these issues. Eventually, the rest of the world will catch on.
Remember the Enron quote from last week’s Journal?
“Of short sellers such as Mr. Chanos, an Enron spokeswoman says: "It was in their financial interest to drive the stock price down, and they raised whatever doubts and whatever issues they could to further their own financial gain."
Well, here is how DraftKings responded to the Hindenburg article.
“This report is written by someone who is short on DraftKings stock with an incentive to drive down the share price. Our business combination with SBTech was completed in 2020. We conducted a thorough review of their business practices, and we were comfortable with the findings. We do not comment on speculation or allegations made by former SBTech employees.”
Funny how these statements sound almost identical, isn’t it?
People that are long want the stock price to go up and those that are short want the stock price to go down. If we care about fair, orderly and efficient markets, which we should, then we should stop attacking the practice of shorting and instead attack the dissemination of false information. If somebody performs research, uncovers some bad facts, accounting issues, legal problems or similar, and decides to take a position on it, great. If somebody just makes stuff up for financial gain, that’s a big problem.
What will happen now? It is hard to say. Let’s look at the aftermath in these three cases, Enron, Nikola and DraftKings.
Enron: Obviously, Enron went down once the facts came to light, taking the revered public accounting giant Arthur Andersen with them. Later, the Supreme Court threw out the Arthur Andersen conviction, but the damage was already done. Here is a detailed narrative of Arthur Andersen.
Nikola: Nikola took a hit after the Hindenburg report came out. It was in the $40s before the report and started a prolonged decline. Shortly after, its founder stepped down from his roles as executive chairman and member of its board. General Motors backed away from an 11% equity stake deal. For a moment it seemed that Nikola was on the verge of collapsing, however, they managed to stay alive and managed to score a deal with CNH. The stock closed at $16.80 on Friday.
DraftKings: DraftKings took an initial hit, plunging almost 10% intraday initially, and has then recovered somewhat.
As far as we can tell, DrafKings did not deny the allegations, at least not officially (though this WSJ article says they are). Jim Cramer appeared a bit shaken initially, giving respect to Hindenburg Research, and its founder Nate Anderson, saying Hindenburg was 4 for 5 before the meme phenomenon took over Clover Health (another SPAC). Watch the video.
Jim Cramer seemed less concerned the next day. He also declared that the Hindenburg report is not a reason to sell:
As Jim Cramer also noted, Cathie Wood’s ARK ETFs bought over $42 million worth of DraftKings shares, which seemed to have helped with the stock recovery. Cathie Wood is also known for being bullish on Bitcoin (she thinks Bitcoin will hit $500,000). More broadly, Cathie Wood, and her ARK funds, are getting a lot of press these days (Bloomberg video, Bloomberg write-up). She seems to have started a trend on actively managed ETFs.
It is Hindenburg’s right to short the stock based on its strong opinion, so is Cathie’s to go long. That’s what is supposed to happen in financial markets. That said, if there is the potential of foul play, that needs to be examined.
We don’t have a crystal ball, but it seems that the story on DraftKings is still being written.