Broker, Trader, Lawyer, Spy - Eamon Javers [81]
Management’s behavior indicates that they will post poor third quarter results, and it is also highly unlikely they will achieve profitability in the fourth quarter. In addition, during a response addressing backlog problems, management fails to comment on part of the analyst’s question related to revenue recognition problems.
That kind of insight could help an investor make a decision to short a stock. Shorting is an investment maneuver in which firms borrow stock in a company and then sell it, betting that the price will go down and they can buy the stock back for less money before they have to give it back, pocketing the difference in price. If the price goes down, they make money. If it goes up, they lose. Basically, shorting is a bet against the company. Good short sellers look for unnoticed flaws in a company and exploit them for gains.
Because they’re always trying to discover corporate dirty laundry, short sellers are particularly good clients for BIA—the techniques taught by the CIA are ideal for scrutinizing executives’ forecasts of their company’s prospects. Short sellers are hated in corporate boardrooms across the country. But BIA loves them.
BIA’s client had no way of telling whether the deception analysis report was accurate or not. It was the client’s job to take the report, combine it with other information known about UTStarcom, and make a bet for or against the company.
With the benefit of hindsight, though, we can go back and check the record to find out if BIA made the right call in 2005.
They nailed it.
Over the next month or so after the call of August 2, UTStarcom’s stock price lost about $1 per share, a nice win for any short seller. But on October 6, 2005, the company released its third-quarter results, shocking NASDAQ traders with numbers that were below the guidance executives had offered during the conference call.2 In October, UTStarcom said it expected total revenues of between $620 million and $640 million, compared with its previous target of $660 million to $680 million. The next morning, investors frantically sold their shares: more than 23 million transactions took place on October 7, 2005. A day after the third-quarter results were released, the stock was down roughly another $2, closing at $5.64.3 It had been at $8.54 when the BIA team listened in on the conference call in August and flagged the potential problems with revenue recognition.
And what reason did UTStarcom give for its poor third-quarter performance? Revenue recognition. In a press release on October 6, UTStarcom said, “The Company attributes the revenue shortfall primarily to the delay in recognition of approximately $40 million in revenue.”
What was much worse for the company was its announcement in the same press release that it was under investigation by the Securities and Exchange Commission (SEC), which it said was looking into “certain aspects of the company’s financial disclosures during prior reporting periods.” That was not the primary focus of the conference call.
Apparently, however, the SEC had suspicions of its own, concerning UTStarcom’s past earnings reports. The SEC proceeding was ultimately settled, with Lu paying a $100,000 civil penalty but admitting no wrongdoing.
IT WAS A PowerPoint presentation like many others in corporate America. It was held in 2006 in the bland conference room of SAC Capital Partners—one of the world’s largest and most secretive hedge funds—on Cummings Point Road in Stamford, Connecticut, a stone’s throw from the sailboat-speckled waters of Stamford harbor. Each attendee was given handouts emphasizing key points of the meeting.
But the session at the hedge fund’s offices was like nothing the money managers in the room had ever seen before.