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The big shorts in the Covid-19 crisis

Nirgunan Tiruchelvam
Nirgunan Tiruchelvam3/27/2020 07:00 AM GMT+08  • 4 min read
The big shorts in the Covid-19 crisis
SINGAPORE (Mar 27): Michael Lewis’s book The Big Short features a hedge fund manager called Michael Burry who profits from the 2008 crisis. Burry was deprived of sight in one eye at the age of two.
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SINGAPORE (Mar 27): Michael Lewis’s book The Big Short features a hedge fund manager called Michael Burry who profits from the 2008 crisis. Burry was deprived of sight in one eye at the age of two.

The boy with one eye viewed the world differently. He rarely made eye contact or socialised with others. Instead, he developed a passion for numbers. In 2007, he heavily shorted subprime mortgages and went on to make US$700 million as the market collapsed in 2008.

Today, short-sellers are among the few that have profited from the coronavirus collapse.

Short-sellers borrow shares and sell them hoping to buy them back at a lower price. They pocket the difference.

In the month ending March 19, shorts in the S&P500 and NASDAQ made US$344 billion ($501 billion). Both indices fell by a third in the period.

Hedge funds and private investors are now loading up their short positions. Many are looking to short the Asian markets, where shorting is banned by some regulators. The market collapse has prompted South Korea to ban short-selling for six months. In Asean, there are only two markets where short-selling is still unfettered – Singapore and Thailand.

There are three types of companies that are in the firing line, as we face an unprecedented shutdown across the region. Discerning investors with an eye on the bottom line should be alert to them.

First, companies with no inventory such as airlines, hotels, and cinemas are weak.

Traditional businesses such as orange retailers carry inventory. If they hold an inventory of one million oranges and sales collapse for a month, they can sell it later. A hotel or an airline, on the other hand, has a finite number of room days or seats. If they do not operate for a month, then those room days or seats are gone forever. There is no way that they can sell it, even at a discount.

Airlines such Singapore Airlines (down 23% year-to-date) and AirAsia (down 61% yearto-date) have all but ceased operations. The planes are grounded and they need to brace themselves for several months or quarters of cash burn. However, it may not be an ideal short at these levels. These airlines may have recourse to government bailout or support.

Second, companies with an operational crisis that have high fixed costs could suffer. Village Roadshow is an Australian cinema and theme park operator that may fit the bill. It operates the Golden Village chain of cinemas, as well as theme parks like Warner Bros and Sea World in Australia.

The fantasy theme parks are now turning into a nightmare. Village Roadshow has just announced that all its operations will cease. Australia has gone into an indefinite lockdown.

The trouble is that its net gearing level of 40% could be unsustainable. Two quarters of an operational standstill could cut its interest coverage ratio to below 1. Labour laws in Australia make it hard and expensive to fire workers. They could deplete its cash. There is a high chance that the 40% dividend payout rate could be cut, which may trigger a further fall.

A final category of shorts are companies that have exploded their debt before the crunch. Minor International is one of the largest hotel operators in Thailand. It is down 70% yearto-date. It has more than 12,800 rooms under brands such as Four Seasons, St Regis, and Marriott.

Minor International’s problem is that it has nearly doubled its net gearing at precisely the wrong moment. In December 2018, it acquired the Spanish hotel operator NH Hotels Group for US$2.5 billion. The deal was financed by debt.

Minor International is bleeding from the collapse in hotel visitors. It needs to generate about US$120 million simply to maintain its interest obligations, while its hotels are empty. There are reports that its flagship Peninsular Hotel, a lavish property overlooking the Chao Phraya River, is operating at 5% occupancy. The European hotels are deserted. It could suffer a 80% fall in operating cash flow in FY2020.

Michael Burry’s conviction that the US mortgage market would collapse was based on assiduous analysis. He saw with one eye what others could not see with two. The 2008 Lehman collapse vindicated him. Investors may want to keep an eye on Asian companies that are scarred by the virus.

Nirgunan Tiruchelvam is head of consumer sector equity at Tellimer (Exotix Capital)

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