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Monday, March 27, 2023

What Are Shorts and Why Does Elon Musk Hate Them?

It was a rough week for Tesla’s share price. After bouncing back from a major dip it took when the Securities and Exchange Commission threatened to sue CEO Elon Musk, and him then agreeing to settle, it’s been on a new downward slide. And it seems to be because of Musk’s tweets, as usual. This time he appears to attack the SEC (calling it the Shortseller Enrichment Commision), and reserves his real ire for short sellers of Telsa stock themselves, as usual.

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Musk called short sellers “value destroyers,” and said that the practice should be illegal. He’s been expressing how much he hates them and warning they’ll lose if they bet against his car company, since 2012, including warning of a “short burn of the century” back in May of this year.

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Before Musk dragged them into the twitterverse, short sellers were not something most prospective electric car buyers had heard of. So what exactly are short sellers, why do they get Musk so riled up, and can they actually impact the future of Tesla?

Traditional investing is all about buying low and selling high. It’s a bet that the value of a company is going to increase over time, so the value of a share in that company will increase too. If the company goes bust, investors risks losing all the money they spent on its stock.

Short selling is the opposite. Short sellers (or shorts) believe a company’s value, and therefore its stock price, is going to go down. They borrow, or rent, shares—typically from large corporate investors, like 401K managers—and immediately sell them. Then they wait, hoping for the price to drop so they can buy them back, return them, and pocket the difference.

Here’s a hypothetical. A short seller would borrow 10 shares of, say, an electric car company, valued at, say, $420, for a total cost of $4,200, which they then sell. If that company runs into problems producing its new product and gets a ton of bad press, or if the CEO of that company starts badmouthing regulators on Twitter, thus exposing the company to lawsuits, the shares could fall to, say, $300. Then the short seller buys back the 10 shares for $3,000 and returns them to the owner. The short seller pockets $1,200, minus rent they’ve paid while they’ve held the shares. (Investment plans make a substantial amount of money renting out shares like this.)

The major risk for the short seller is that the price could go up. The company’s CEO could settle a lawsuit, and the company could post good production numbers for its new product. If share prices keep climbing, the cost of buying the 10 shares goes up, potentially by a lot. That makes short selling too risky for most mainstream investors, because they can lose a lot more than the money they put in.

Companies, and their CEOs, hate short selling. Just having shares short-sold devalues them. That’s because there are more of them up for sale—more supply—but the same level of demand. Which can drive prices down. And while a company can carefully control supply by determining how many shares it issues, it can’t control how many hit the market after they have been borrowed and then sold by short sellers.

“It puts downward pressure on the stock, and that’s not good, when your daily report card is the stock price,” says James Cox professor of corporate and securities law at Duke University.

This is not a problem that’s unique to Tesla. Apple and Amazon are also highly shorted stocks. Their CEOs are just less outspoken about it.

But the thing that makes Elon Musk so mad is that short sellers are motivated to find and spread negative information about the company. The worse the company performs, the more money short sellers make. “They do have a strong incentive to see stock price go down,” says Cox.

But short sellers aren’t doing anything illegal. They believe they’re highlighting real issues with a company. On Friday, Bloomberg reported that David Einhorn, a large hedge fund manager, and famed Tesla short seller, is now comparing the company to Lehman Brothers Bank in a leaked letter.

He says at Lehman Brothers, managers made threats to short sellers and publicly suggested going private. The bank folded in 2008, the largest bankruptcy in US history, and a catalyst for the global financial crisis. (Lehman guys would say the short sellers caused it.)

“Like Lehman, we think the deception is about to catch up to TSLA,” Einhorn reportedly says. (Einhorn declined WIRED’s request for an interview.)

Amateur investors would also say they are merely exposing the company's problems. They retweet what Musk would characterize as negative stories, but which they see as revealing (like a New York Times report into parking lots full of Tesla inventory cars).

“Elon's cult of personality has attracted thousands of people who simply cannot believe he could ever fail or be wrong,” says one amateur investor over Twitter DM. He goes by the handle of @PlugInFUD and asked for his real name to be protected given Musk’s history of lashing out against critics. “These are the same people who get harmed when Elon tweets fake buyout offers, goes on twitter rampages late at night, etc. We shorts really just want to see an end to this farce, one way or another.” Short sellers like him are unapologetic about being negative on a company, believing they’re helping to expose and unravel frauds. But they’ll also make a profit on it, which muddies the motives.

Musk’s typically outspoken attitude on Twitter, attacking not only short sellers, but also the SEC, isn’t doing Tesla any favors. He’s highlighting what he sees as a problem, but he’s not looking like traditional CEO leadership material while he does it.

“The more he gets worked up, the more questions there are about his keeping his hand on the tiller,” says Cox.

It’s a sentiment echoed by even Musk’s most loyal fans, replying to his tweets, wondering if he’s doing the right thing. That reduces confidence in Musk, and therefore in Tesla, the company he’s inextricably linked to, and pushes down the share price—exactly what the shorts want. The best advice for him is the same as that which he always ignores. Stay off Twitter.

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