Worst stocks win awards in hedge fund 'short' contest


Move over, Bill Ackman. It's time to reveal some of the hedge fund community's best short ideas from investors who normally stay out of the spotlight.

The results are in for the FactSet Top Idea Tournament Best Short contest, run by SumZero, a community for analysts at hedge funds, mutual funds and private equity funds. The contest, which was open to the 10,500 members of the SumZero community, accepted short pitches on virtually any stock with a market capitalization of $500 million or more. The contest is the second in a four-part series that includes $160,000 in cash prizes.

Coming in first place was a pitch to short Harvey Norman Holdings, an Australian retailer with a market capitalization of 3.7 billion Australian dollars ($3.3 billion). The idea was pitched by Sid Choraria, an analyst at APS Asset Management, a $3 billion hedge fund in Singapore.

A customer walks through the showroom of a Harvey Norman store in Sydney.
Ian Waldie | Bloomberg | Getty Images

Choraria argues that Harvey Norman faces structural headwinds from a steady increase in in competition—both physical and online rivals. Much like Sears and Best Buy in the U.S., Harvey Norman is at risk of losing share to websites that can deliver items such as electronics at low prices and may not charge sales tax.

The problem could be worse for Harvey Norman because it employs a franchise model, meaning franchisees will suffer even if the company succeeds with a website of its own.

Harvey Norman's franchise model has an unusual quirk: It has recently paid franchisees hundreds of millions of dollars to help them cope with the tough business environment. Choraria argues that the company is effectively forced to support its franchisees with increasingly large payments or they would not be able to survive.

On top of that, rents in Australia have been soaring, putting a further strain on franchisees.

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Choraria believes Harvey Norman shares look overvalued, trading at more than 40 times free cash flow. Such a valuation appears unsustainable given headwinds that aren't going away anytime soon, he said. Harvey Norman's chief financial officer, Chris Mentis, didn't respond to a request for comment from CNBC DIgital.

Choraria's firm, APS, was founded in 1995 and focuses on bottom-up analysis of companies across Asia. Choraria joined APS earlier this year and Harvey Norman was one of his first investing ideas in his new role. "I've been greatly inspired by reading letters of Berkshire Hathaway," he said. Choraria has won awards in multiple investing contests hosted by SumZero. Before APS, Choraria worked in the investment banking division of Goldman Sachs in Hong Kong and has an MBA from NYU.

Second place went to a pitch to short Kandi Technologies, a U.S.-listed company that produces electric cars in China. The idea came from Karl Richter, founder of Tectonic Investments, a Philadelphia-based fund focused on technology, along with industrials, energy and materials.

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Richter raises serious questions about the company's ability to maintain the growth it has reported. He argues that investors may think the company is the "Tesla of China" but it has very low odds of achieving such success.

He said the company caught his attention in part because it has a market capitalization of about $600 million but isn't covered by a single analyst. "We ran a screen of market capitalization divided by the number of analysts," Richter said. "In this case, the denominator was zero."

Richter said he also questioned the company's choice of financial auditor. Rather than a major firm, Kandi continues to retain Albert Wong & Co., an agency that focuses on companies with tiny market capitalizations—essentially penny stocks. Albert Wong didn't respond to a request for comment from CNBC Digital.

Kandi investors also appear excited about a joint venture with Geely, the owner of Volvo, Richter said. But based on his analysis, Geely has made a very small contribution to the JV and won't be involved in the future. Kandi and Geely didn't respond to requests for comment from CNBC DIgital.

Richter said he has been covering electric cars for years, focusing on all elements of the supply chain. He founded Tectonic in 2013 and previously worked for firms including Susquehanna International Group and SAC Capital Advisors. He is a graduate of MIT.

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Third place went to an idea to short REC Silicon, a Norway-listed company that mainly produces polysilicon used in solar panels. The pitch was submitted by Shawn Kravetz of Esplanade Capital, a Boston-based firm founded in 1999.

Kravetz argues that REC is a well-run company, but it is vulnerable to a change in Chinese law that could have catastrophic consequences. He points out that the majority of REC's polysilicon is shipped to China. Unfortunately, China plans to begin imposing a steep tariff in 2015 on polysilicon imported from the U.S., where REC conducts most of its production.

Kravetz said that when news of the Chinese tariff came out, the stock was trading at a 15 percent premium to the group. The company now has "a sword of Damocles hanging over its head," he said. "The stock shouldn't trade at such a premium."

Without China, REC would likely be unable to sell its polysilcon inventory, he said. "There's not enough demand for it outside of China," he said. REC didn't respond to a request for comment from CNBC.

Kravetz said he has been following REC since it went public and has actually owned the stock in the past. Kravetz also owns another polysilicon maker that trades at a lower multiple. His fund focuses on a range of sectors including solar power, casino gaming and consumer products. Kravetz has a degree in economics from Harvard and attended Harvard Business School.

The winners were selected by 18 judges comprised of hedge funds and major asset allocators. They incuded Glenn Tongue of Deerhaven Capital Management, MIT Investment Co., Robert Wood Johnson Foundation, Quincy Lee of Teton Capital Partners, Tom Saberhagen of Akre Capital Management, Zeke Ashton of Centaur Capital Partners and University of Notre Dame.