Idea Brunch with Gabriel Grego of Quintessential Capital Management
Gabriel Grego on exposing frauds and fighting the good fight
Welcome to Sunday’s Idea Brunch, your weekly interview series with underfollowed investors and emerging managers. We are very excited to interview Gabriel Grego!
Gabriel is currently Managing Partner of Quintessential Capital Management, a long/short global equity fund he founded in 2008. Gabriel is well respected for his ability to expose frauds. Some of Gabriel’s notable campaigns include American Addiction Centers, which went bankrupt, Folli Follie, which went bankrupt as well, and Bio-on, which also ended in bankruptcy. Before founding Quintessential Capital, Gabriel was a Vice President of SFK Finance & Projects and a volunteer paratrooper in the Israel Defense Forces.
Gabriel, you have an unmatched reputation for exposing frauds. What are some of the common factors in the companies you investigate and why are you so good at exposing frauds?
Well we have had some success in exposing frauds, though many of our peers have been far more productive in terms of frequency of campaigns. I think what differentiate us the most from many other short sellers are the following elements:
Focusing on companies with hidden, catastrophic situations. We shun overvalued stocks, weak managements, minor conflicts of interest, etc. Typically, we go only after total fraud or management committing serious crime. This has a number of advantages: first, price impact tends to be stronger. Second, we receive less long-term backlash because most people ultimately understand and agree with stomping out fraud. Third, it probably reduces legal risk.
We only publish if we believe our thesis is definitive and proven beyond reasonable doubt. We don’t believe in publishing “red flags”, but only in showing “smoking guns”.
We use also use extensively (legal) non-conventional research tactics which include, for example undercover work. Very often, these tactics give us a powerful information advantage and allow us in probing our targets in far greater depth.
Taken together, these factors have generated a track record that we are proud of, though there is room for improvement. The flip side of the coin, as I mentioned earlier, is that such a thorough due diligence and selection process is bound to reduce our productivity to only a few campaigns per year.
How do you originate your research ideas? Are there any methods that have proven particularly fruitful?
I think it pays casting as wide a net as possible and using multiple idea generation mechanisms. The best ideas usually come from reading carefully existing literature from other players and paying attention if anyone detects red flags in a particular company. Our job then is to turn those red flags into smoking guns by way of additional deep research.
That said, we also use conventional computer screening systems flagging for typical accounting red flags like frequent changes in auditors or discrepancies between cash flows and earnings. We also subscribe to a few excellent third-party research services which provide initial analysis or flag corporate governance issues.
Occasionally, we run into good ideas starting from our long research activity: a company may initially look like an attractive value target, but under careful scrutiny we run into skeletons that may suggest the existence of fraud.
Finally, another well-known and effective system is to keep track of people and entities that have been associated with past frauds: their habit is hard to break and typically they keep doing it over and over. This is not only true of corrupted CEOs, but also board members, auditors, law firms, etc.
You’ve recently been active in exposing problems at Cassava Sciences (NASDAQ: SAVA). Can you tell readers a little about what is going on there?
We believe that Cassava Sciences is a terrible scheme to enrich management at the expenses of other shareholders. For those who are interested in learning more I would suggest reading our report on the company which is entertaining as well as informative. In summary, Cassava claims to have found a drug capable of reversing the course of Alzheimer’s Diseases, improving certain bio-markers and reversing the patients’ cognitive decline.
Along with other skeptics, we have discovered convincing evidence that this is not so. The compound has been discovered by a Chinese scientist from CUNY named Dr. Wang. Many forensics experts have found evidence of forgery in several papers published by this individual, including in critical research supporting Cassava’s only drug, Simufilam. In addition to this, our proprietary due diligence discovered that many key actors involved in the testing of this drug have a highly questionable past (e.g. former felons, fraudsters, drug addicts) and may have been in conflict of interest. Also, we showed how the much-touted cognitive improvement of Cassava’s drug, may simply be the result of biased patient enrollment and cherry picking of data. The alleged fraud would have been facilitated by the limited number of patients involved in a stage II trial, which is geared more toward establishing safe dosage than drug effectiveness.
Our report was vindicated only a few days later as the WSJ published an article claiming that Cassava is now under investigation by several federal agencies including the SEC and the NIH.
Unlike many other activist short-sellers, you have also been successful investing in companies. Do you find there is any overlap between your work as a short seller versus long investor, or are they two completely separate skillsets? What does your work on the long side look like?
There is some overlap, though the two activities require profoundly different skill sets. The habit of knowing a company “inside-out” through the deep due diligence necessary for a successful activist campaign is a skill which that fits long investing as well. After all, you can never know too much about a potential investment target. Also, short selling requires a certain degree of skepticism and refusal to take management’s words at face value: everything must be verified, if possible, by multiple independent sources. This approach, when applied to long investing, can help you avoid bad surprises and occasionally uncover “hidden gems”.
By the way, that skepticism should be applied to your own investment management skills as well: in many circumstances there is no probable alpha to be found in long investment, and the best approach is a passive buy & hold strategy.
Also I would add that successful activist short selling is great training for activism in general: in the few times that we attempted something that looked like a long activist campaign, if felt almost like a “walk in the park” compared to our short activism (no threats, abuse etc.).
That said, activist short selling will always be a much harder endeavor than its long counterpart. First, the risks involved (market, legal, physical, reputational) are much greater. Second, the information required is much harder to find as, unlike in a long situation, when you are researching fraud the target company is doing everything in its power to conceal from you what’s really going on. The amount of mental fortitude required is also considerable, especially when you are successful: management will do everything it can to avoid its own demise and that often means attempting to hurt you.
What are one or two interesting ideas on your radar now?
We obviously cannot disclose our activist short targets. I can tell you that we are looking at opportunities in Europe, rather than in the US, very closely. For a number of reasons, I suspect there are more accounting frauds in the Old Continent and the regulatory environment has become more benign lately.