Updated: Nov 25, 2020
From the desk of Jeroen Bakker
Benelux Consulting Lead, Pierpoint Financial
In the ninth episode of (In)Famous Securities Lending Transactions, we continue our commentary on stocks that are in play in the securities finance world. In this episode, I look at the Canadian business jets and public transport vehicle producer Bombardier. The reason for this episode’s topic is the recent investigations by the Serious Fraud Office in the UK over suspected bribery and corruption concerning orders from Garuda Indonesia.
So does this investigation warrant hedge funds to short the stock and if so, what is their potential profit? With the securities lending data provided by FIS Astec Analytics, I am going to investigate this and see if there is increased activity in this name.
Bombardier Inc. is a Canadian multinational that was founded in 1942. It is a manufacturer of business jets, public transport vehicles, and trains, with the latter two businesses pending sale to Alstom. It has two headquarters. The aviation division is headquartered in Montreal, while the transportation division is headquartered in Berlin. The company was originally created to produce snowmobiles, but it expanded into the aviation, rail, and public transit businesses.
The share price has lost most of its value in the last two years, as it has been close to bankruptcy the entire time. The pandemic hasn’t helped the performance of the company, but the writing has been on the wall for Bombardier long before COVID-19 made its appearance. Bombardier has been selling their assets for quite some time now, their exit from commercial aviation was completed when they sold the final piece to Airbus earlier this year, while the transportation division is pending a sale to Alstom. This leaves the company heavily exposed and centred around its business aircraft market, which is not a great space to be in while the virus remains a global issue. Even looking beyond that, how much need will there be for business aircraft, as companies re-examine their travel needs (both commercial and private).
Bombardier is the latest aerospace group to face scrutiny after Airbus and Rolls-Royce, both of which have made settlements with regulators on deals involving sales of planes or engines to Garuda. At the centre of the Bombardier case are five procurement processes, including the 2011-2012 acquisition and lease of Bombardier CRJ1000 regional aircraft by Garuda. Under the system of plea bargains used in the UK corruption cases, companies can get more lenient fines if they bring potential wrongdoing to the attention of authorities themselves.
The first graph is a three-year look back at the securities lending fees and utilisation for Bombardier stock.
As the graph shows, there has been limited to no interest in shorting Bombardier up until mid-2020. Before that time levels were very GC and utilisation below 20%, which in itself is already rather strange if you look at the share price. Missed opportunity? Yes, if you are asking me, as an investor could have ridden a $5.00 to $0.30 downward wave at a reasonably cheap fee level (less than 25bps per annum).
In order to get a better view of the latest short interest in Bombardier, I have taken the last six months of SBL data. Even though the SFO investigation was only made public at the beginning of November 2020, the trend of investigating aircraft transactions with Garuda has been going on for several years (Airbus/Rolls Royce).
The six-month graph shows a picture of what we have seen many times before; first, the utilisation levels rise followed by the fee. However, in the Bombardier case utilisation levels did not remain at extreme levels as you experience with uber specials. Utilisation level plateau at around 50% while the fees settle in the region of 40 bps, after a short spike.
The actual announcement by the SFO seems to have had little to no effect on the levels.
Back to the original questions: Does the SFO investigation warrant shorting Bombardier, and would it be profitable? The old verb “Buy the rumour and sell the fact” can be applied here as well, but in a slightly different format: “Sell the rumour and buy the fact”. Shorting Bombardier shares based on the SFO investigation is not selling on a rumour, but it is acting on a hunch that the outcome of the investigation will be detrimental to the share price of Bombardier. With an SBL fee of less than 40 bps, the cost of shorting is not going to ruin the trade either; however, something else just might.
That something else is the current share price of Bombardier. At C$0.30 the best outcome for a short seller is very limited – C$0.30 while the potential loss (as with all short positions) is limitless. Selling 10 million shares of Bombardier, for which there is plenty of inventory available, would net at best C$ 3,000,000 and with a borrowing cost in the region of C$12,000 per annum ex collateral costs, but even a 50% drop in share price would “only” generate a gross profit of C$ 1,500,000. Chances of a further drop in share price are minimal as there will always be some residual value in the company that gets reflected in the share price. If Bombardier gets out of the investigation without any blame or limited fines, the stock could bounce back. Bouncing back to mid-2018 levels could potentially generate a loss of C$ 47,000,000. That might be exaggerating it a bit, but even at early 2020 share prices, the trade would still be at a loss of C$17,000,000.
Try explaining that to your investors……