Planting the seed of doubt – a lesson in sobriety


The information in this article is market commentary only and reflects Lincoln's views and beliefs at the time of preparation, which are subject to change without notice. To obtain up-to-date information, please contact us.

On the morning of Tuesday 6th August, the shares of agricultural trust Rural Funds Group (RFF) went into free fall, down 42% before a trading halt was placed. The reason? An overseas activist short-seller, Bonitas Research, published a damning report on the trust asserting a range of issues with the business which effectively resulted in a zero valuation for the company.

So why the savage drop based on one firm’s view of a company? Isn’t it true that there’s always someone who doesn’t think a share is worth holding when they sell it on the market? So what made this scenario unique?

First, as is the style of most activist short-sellers, they make their reports readily available to the public in a ‘shock and awe’ style approach to monetising their views rather than keeping the information in-house to trade on.

Second, Bonitas was founded in 2017 by Matthew Weichert who was also a joint founder of Glaucus where there’s pedigree when it comes to picking potential disasters. In Australia, the public outed Blue Sky Investments and Sandalwood grower Quintis Ltd who ultimate went under. Overseas they had made similar assertions on many others, where companies have since failed, or share prices have not since recovered.

Lastly, there were some severe allegations thrown at RRF in this report. Claims such as aggressive asset valuations, fabrication of rental income, conflict of interests between related parties and finally, claims of nefarious transactions were enough to make the heart of most investors including ourselves as a Fund Manager and holder of RFF, skip a beat or three.

Short selling is not a fait accompli

It is important to note here that Short Selling is not a new phenomenon and has been around investing markets for a very long time. Nor does a stock being heavily shorted mean that a company’s share price will fall. Take JB-HiFi Ltd (JBH), for example. The company has had over 10% of its stock shorted since May 2017, and yet the share price has risen well over 30% in that time. Even our main protagonist, Bonitas/Glaucus has had calls in the past that haven’t worked out.

In the meantime, RFF has resumed trading following a passionate refutation against the claims. The share which had fallen from $2.32 down to $1.36 before being halted, has since rebounded close to 50% to around $2. Only a mere 13% from its high, a significant drop, but not worthless. The company has since opened its books to a reputable third-party audit with the result expected to be known shortly. And the Directors, including founder David Bryant have bought sizeable chunks of stock as a sign of commitment and confidence in the entity.

This will likely not be the last we hear of the RFF saga. We have retained the stock as a Star Income Stock as we deem the risks associated with the Bonitas report have been reduced following our preliminary investigations and discussions with management.  But it’s not quite case closed yet. We eagerly await the independent third-party audit report, and we are yet to conclude our formal investigations into the business which are expected to take some time.

Lessons learnt

Events such as these are often filled with lessons that investors can take away and incorporate with their investment strategies to help manage and/or avoid such incidents in the future.

Companies that are reliant on complex internal structures are becoming a focus for a short thesis. Businesses where there are inter-party related transactions, complex tax arrangements, and opaque asset valuation techniques are ripe for questioning, and therefore, you should consider. Open and transparent accounts make such attacks less likely as everyone has access to all the information.

Don’t just look at the level of shorting in the stock as a red flag. The trend can be just as important. Though RFF had just under 3% of its shares shorted at the time of the Bonitas report, it had risen from a level of 0.3% two months earlier.

Savage price swings remind us of the perils of automated predetermined stop losses. While online brokers sell you on the convenience of pre-setting your stop levels, irrational days such as that Tuesday can leave many investors disappointed. While no one likes to lose money, you are best to take the hit, block out the noise, and then make a calm and collected decision on what’s next based on facts. Remember though, just because the price has bounced doesn’t mean you might not still decide to sell it based on the current risks at hand.

Finally, since being introduced as a Star Income Stock in October 2015, RFF has returned, including distributions, 84.65% (18.05% pa). We would expect in that time investors would have been taking profits as a means of rebalancing the portfolio and ensuring there was no over concentration risk. This is something we educate our investors on regularly and our Managed Funds proactively do as well. Taking profits is a great way to build a cash pool to pounce on future potential buying opportunities that irrational markets can create. They can disappear quickly and without the cash ready to go you might miss it.