Rob Shand was 18 minutes into the most anticipated company event of the week.
It was Wednesday morning and the Blue Sky Alternative Investments managing director had the ear of the Australian market after calling a conference call the night before to expand on his response to what the company called a "foreign shorter opinion".
One week earlier, Glaucus Research Group, a US activist hedge fund, rocked the market when it dropped its extensive short thesis on the Brisbane-based Blue Sky claiming the ASX-listed fund manager was overstating its assets. The revelation triggered a 9 per cent collapse in the share price before trading was halted.
"We have been both deeply humbled and overwhelmed by your support and we thank you for it," the 36-year old said, concluding a composed but probably scripted address.
Trading in Blue Sky shares was due to reopen for the first time since the previous Wednesday collapse after Shand's investor call. But after thanking the listeners he made a stunning error of judgment.
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Shand repeated his invitation for Glaucus to come meet with his "team" and with that the Blue Sky camp shut down any opportunity for questions.
In that instant, the brutal week-long battle tipped emphatically in favour of the aggressor.
Shand in fact spent that day and subsequent days reassuring investors that he would win the public battle with Glaucus. But his silence on the call was deafening.
His fortress approach appears even more reckless because of the reality he and Blue Sky have quietly been at war with short sellers, as AFR Weekend can reveal, from the moment he took charge succeeding predecessor Mark Sowerby in August 2016.
Starting with Sowerby
Sowerby built the alternative asset manager into half-billion-dollar business. A serial entrepreneur and adventure junkie who swam the English Channel, Sowerby offloaded 3.4 million of the 8.4 million shares he owned to trusted institutions OC, Industry Funds Management and Fidelity. Sowerby's DNA was Blue Sky's DNA when he stepped down.
The decision to sell his shares and anoint Shand is described as being a sensible strategy, but for investors who monitor changes in management selling it was a red flag. They would become the thorn in the young but expertly qualified former chief operating officer's side.
Shand had the task of keeping his new institutions onside (some of which were actually a source of stock lent to the shorts) and carry Blue Sky to greatness.
The bulls believed Blue Sky was the second coming of Magellan, a 10-bagger for those who were smart enough to read its potential early. While Magellan's Hamish Douglass pedalled the virtues of global investing, Sowerby and the highly motivated Blue Sky team trumpeted alternative assets such as private equity, venture capital, water rights and property. The opportunity in these illiquid assets was immense, and they set about fostering relationships with connected advisers and wealthy Australians willing to lock their money up for years earning impressive returns.
Blue Sky was making a claim to being the KKR of Queensland.
Blue Sky like Berkshire
Every December over 1000 investors in Blue Sky funds flocked to Brisbane for the annual investor day likened to the annual general meeting of Warren Buffett's Berkshire, which Sowerby was known to attend.
But that enthusiasm wasn't shared by some analysts who believed that Blue Sky's earnings were largely predicated on the value of those illiquid assets perpetually increasing. Blue Sky forcefully and repeatedly rejects any allegations of overstating asset values, and has identified the names of third party valuers and auditors which sign off on its accounts.
For a bull or a bear, getting a complete picture of Blue Sky was challenging given the 80 funds it managed and the consolidation of its accounts at the parent level. Some that tried were called out.
In December 2016 highly regarded analysts at Diogenes Research published a 16-page report detailing several points that dented the Blue Sky story. That includes its fee structure, the debt within its funds, how it values those assets and its growing exposure to property. It also made note of Shand's incentive target with options issued at a strike price of $7.74 that will vest when $5 billion of fee-earning assets under management is reached by 2019.
Blue Sky reportedly took exception to the report, according to The Courier Mail.
Results spoke for themselves
The best way to beat the shorts, however, is with results. And the Blue Sky juggernaut rolled onwards to its ambitious target of $10 billion of fee-earning assets under management, its preferred way to communicate guidance to the market.
Finishing 2016 at $7, the shares were testing $10 by August 2017. Those betting against the company were scrambling when some loaned stock was recalled, triggering a squeeze. The stock went beyond $14.
The company secured a prestigious partner in Goldman Sachs in March 2016 which would back its foray into student accommodation. Blue Sky and the Goldman special situations desk, typically a three-to-six-year investor, were on to their seventh raising.
For the shorts, Blue Sky has been a painful trade that few, paying an estimated 8 per cent a year, could afford to maintain. Its performance was flawless.
But some shorts could not shake their discomfort with Blue Sky's numbers.
Issues were raised around the use of the listed investment company to seed new funds, and the sustainability of high upfront transaction fees charged (Shand, however, describes Blue Sky's fees as fair). Sources said the company believed providing a breakdown of transaction and management fees was not in the interests of shareholders.
Also, Blue Sky eventually might have to exit some of its property investments at a time when the apartment market was showing signs of turning, they surmised.
Questions on assets and fees
Blue Sky declined to split assets under management into the four classes – private equity, real estate, real assets and hedge funds – which concerned some governance experts. Some of these aspects were part of the Glaucus thesis, others were not.
Arguably, the company suffered from weak earnings quality because performance fees based on unrealised gains were growing, identified by the receivables on its balance sheet. And the pending accounting changes that would affect how performance fees are recognised was another source of uncertainty.
For all of these talking points, none mattered when Blue Sky announced a bumper interim profit and upgraded its fee-earning assets under management figure again in February.
But the granular detail of the interim accounts galvanised the shorts, who reckoned that Blue Sky had slowed its exits, while its receivables were still rising, suggesting more of its profits were of the paper kind.
Capital raising
In March at $11.50 a share, Blue Sky raised $100 million capital, which for a scalable business like funds management defied conventional wisdom. Blue Sky told investors the money would be applied to future funds, platforms and joint ventures; additional capital for ongoing co-investment; and to cover raising costs.
Blue Sky had, according to three sources, been able to trace the identities of hedge funds borrowing shares from the prime brokerage desks of the investment banks. Morgans and Shaw stockbrokers, who handled the raising, were under strict instructions not to allocate any shares to the short sellers, which Blue Sky is within its rights to do. This is not unique but what stunned some shorts was the level of detail Blue Sky had managed to compile on their positions.
If they wanted to cover their positions they would be forced to do so buying on-market.
Glaucus drops
Then Glaucus dropped its 67-page report, which claimed Blue Sky shares were 77 per cent overvalued, the company was charging exorbitant fees to its investors, while its returns, if they were to be believed, made it among the best financiers in the world.
Glaucus head of research Soren Aandahl, who built his reputation smoking out Chinese frauds, is one of a new breed of short activists to successfully target Australian companies after unearthing the admission from sandalwood firm Quintis (then TFS) that its biggest customer in China had disappeared.
As the Glaucus report circulated, Blue Sky's stock fell. Aandahl later said that he had heard versions of Blue Sky's defence before: "Calling people a conspiracy of short-sellers is one of the oldest, silliest attacks in the book. Almost every company that has collapsed under evidence of fraud after our short-selling research has made a similar accusation."
But with one trading day before the Easter weekend, Shand and his management could bunker down and craft an expert dismantling of Glaucus' piece.
He emailed his supporters. Fellow director and venture capital advocate Elaine Stead retweeted messages of support. Their candour was endearing, and it appeared Blue Sky was honing an authentic message.
Blue Sky's management submitted its response to the exchange for publication, but as the exchange asked for clarification on certain points, it was not released until after market. The conference call set for Wednesday morning was not to be missed.
Already worryingly for some, Blue Sky was adamant that information it was being asked to disclose about its assets was confidential and would be withheld. As Shand's call concluded, things would get worse.
Glaucus' rebuttal was more articulate, and more damaging. But shorts were not necessarily riding the price all the way down because longs were said to be recalling loaned stock for the purpose of exiting themselves.
Shand's performance options fell out of the money. But on Friday, it emerged that directors were at least willing to back their leader and had been acquiring stock on market. Glaucus' $2.66 target price, by the way, has still not been breached.
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