Short Road to Success : Investing: The Feshbach brothers of Palo Alto have made a fortune betting that stocks will go down. But some critics question their short-selling methods.
One quick glance around the Palo Alto offices of Feshbach Bros. suffices to show that this is no typical bullish investment firm.
First, there are the bears: stuffed Teddy bears, bronze bears, ceramic bears, crystal bears, paintings of bears.
Then there is the bust of the late L. Ron Hubbard, self-styled management guru and founder of the controversial Church of Scientology, which has waged fierce battle with the Internal Revenue Service over its tax-exempt status.
There are also dozens of Hubbard’s tomes, a poster advertising his self-help book “Dianetics” and, pinned to walls and bulletin boards, copies of Scientology-inspired organizational charts.
The Feshbachs run their firm strictly according to Hubbard’s principles, and they contend that Scientology accounts for their success. They often speak at Scientology meetings and proselytize among their investment contacts.
The Feshbach brothers--Kurt, 38, and twins Joe and Matt, 37--have gotten rich and famous (on Wall Street, at least) by being atypical in both their professional and personal lives. They have also irritated a lot of people, usually executives whose stocks--and reputations, many contend--have been slashed by the claws of these stock market bears.
Even in the long-running 1980s bull market, the Feshbachs, who make their money when stock prices go down, managed to reap substantial profits. But now that the market has been jolted by the Persian Gulf crisis, things have gotten a lot easier.
“Are we happy there’s a war? No,” said Joe Feshbach, who acts as the firm’s spokesman. “Of course, we’re happy making tons of money. It is refreshing to have the wind at your back.”
Unlike most other investors, who hope to profit when stocks do well, the Feshbachs, along with Dallas-based partner Tom Barton, zero in on issues that they expect will plummet because of being overpriced, overhyped or downright fraudulent. These self-described “stockbusters” sell borrowed securities in the expectation of replacing them at a lower price, an oft-reviled but growing practice known as short selling.
Already the biggest and best-known of the short sellers, the Feshbachs have lately become even more influential as investment managers seek their advice.
One recent evening at a park near the Stanford University football stadium, more than 100 stockbrokers and money managers from First Boston, Wertheim Schroder & Co. and other firms played volleyball and schmoozed about stocks at the “first annual Feshbach Bros. BBQ.”
The Feshbachs’ main investing pool is Southgate Partners, a 5-year-old limited partnership with 90 investors and about $480 million under management. It has never had a down year, with the best being 1986 (when gross returns were up 62%) and the worst, 1989 (up 20%). Based on unaudited in-house numbers as of Sept. 30, the firm has shown gross gains of nearly 60% this year, compared to a drop of 13% for the Standard & Poor’s 500-stock index.
The Feshbachs hold short positions in about 200 stocks. From clients, including Dreyfus Corp. and Frank Russell Co., a pension consultant, they collect a 1% management fee and a 20% commission on all profits. If the bearish mood prevails, Joe Feshbach said the firm stands to make more than $50 million for 1990.
The brothers, who manage a total of $850 million, also operate Stockbridge Partners, a brokerage, and Junkyard Partners, a junk bond fund.
Short selling works like this: Short sellers borrow shares, usually from a brokerage margin account, then sell them immediately at what they hope is an inflated price. They wait--sometimes as long as two or three years--for the price to sink before they repurchase the same number of shares and return them to the broker to “cover their position.” The harder the stock falls, the bigger the short sellers’ profit. If they guess wrong, they stand to lose a bundle if they have to cover at a higher price.
Short selling, which accounts for a tiny portion of stock trading, is not for the faint of heart. Joe Feshbach acknowledges: “I hate the nerve-racking nature of it.”
Feshbach fans value their intensive research. Of the firm’s 60 employees, 18 are in research. In addition to poring over financial documents, they call a company’s competitors, suppliers, customers and former employees to try to spot weaknesses. Occasionally, the firm will hire private detectives.
It was a Feshbach analyst using old-fashioned detective-style digging who uncovered fake contracts at ZZZZ Best Co., the infamous Reseda-based carpet-cleaning company. ZZZZ Best went bankrupt in 1987, and its whiz-kid founder, Barry Minkow, is in jail. The Feshbachs made big money.
They have made other killings in Zondervan Corp., a leading Bible publisher; Cannon Group Inc., once a high-flying producer of low-budget films, and American Continental Corp., the bankrupt former parent of Lincoln Savings & Loan. They shorted American Continental at an average of $7 a share and covered, after regulators seized its Irvine-based thrift, at 87.5 cents. (Charles H. Keating Jr., American’s former chairman, has been indicted on charges of violating state securities laws.)
Unlike many other shorts, who usually maintain a low profile, the Feshbachs invite publicity. Joe Feshbach asserted, however, that 98% of the firm’s contacts with the press are initiated by reporters.
“We have a legitimate right to express our opinion,” he said. Besides, in his view, investors far more often get hurt by companies that tout favorable developments or hyped projections and then fail to live up to them.
When the Feshbachs target a stock, they often go further than simply taking a short position. Their actions range from sharing information with other fund managers to answering reporters’ queries to tipping off regulators when they smell something fishy. After all, a Securities and Exchange Commission investigation seldom causes a stock to rise.
“If we give information about something to the SEC, as long as we believe it to be correct . . . then we’ve just been good citizens,” Joe Feshbach said.
Yet critics contend that the Feshbachs’ decision to take a short position in a stock can turn their negative opinion into a self-fulfilling prophecy as others follow suit, and confidence in the issue erodes.
Critics also say some short sellers spread false rumors about their targets and plant seeds of doubt in the financial press.
Back in 1984, Melvin Lloyd Richards, founder of a Glendale-based oil and gas company called Unioil, declared to angry shareholders that short sellers led by Kurt Feshbach had planted misstatements in the press that resulted in the collapse of Unioil’s stock. He denounced the Feshbachs as members of a “religious cult.”
Although Joe Feshbach acknowledged that the Feshbachs were short on the stock at the time, he suggested that the company’s fortunes soured because of fundamentals. He pointed out that Richards later was sentenced to prison for mail and income-tax fraud related to a uranium mine tax shelter.
One of the Feshbachs’ most outspoken foes is Robert J. Flaherty, a former writer for Forbes magazine who is now editor of the New York-based publication Equities, formerly OTC Review.
Flaherty often writes about alleged dirty tricks by short sellers. He says negative campaigns by short sellers have occasionally damaged start-up companies that otherwise might have thrived.
Concerns about short seller abuses prompted congressional hearings last year. And the Assn. of Publicly Traded Companies, a Washington-based group of firms with shares traded over the counter, is seeking legislation that would, among other things, require filings by short sellers with big positions, similar to 13-D filings by investors with long positions.
In August, Herb Greenberg, the San Francisco Chronicle’s market columnist, wrote that the SEC had queried him about the Feshbachs’ “relationship” with columnists “such as yourself.” Greenberg and other columnists routinely quote the Feshbachs. Some critics such as Flaherty say shorts use reporters to help drive down stocks.
Greenberg said any writing about stocks is open to such charges. “We get ‘used’ by people all around who try to tell us good stories,” he said. “The shorts are no different from the longs.”
Experts say short sellers perform a legitimate function in bringing balance to the markets.
“Knowing that our basic incentive is profit,” Joe Feshbach said, “we do think there is a great deal of social good that comes as a result of short selling. It serves as a sort of ballast where there’s hype and overvaluation.” Besides, he added, “good companies don’t complain about short sellers.”
The Feshbachs occasionally guess wrong in dramatic style. A loser early this year was footwear maker L.A. Gear, although the Feshbachs continue to hold a “very, very large short position.”
The Feshbachs’ influence is especially remarkable given their lack of fancy business degrees and their relatively short tenure in the investment community.
In 1981, Kurt, a high school dropout, was a diamond broker. Matthew, who never attended college, was running a tennis school and store in Menlo Park. Joe, who briefly attended Utah State University, had become a volunteer minister for the Church of Scientology after converting from the family religion, Judaism.
Their father, Bernard, encouraged them to join his business, public relations for small energy companies. Soon after, the brothers stumbled onto what became their first short target--an oil and gas venture that had a $45-million stock market value despite low sales and a lack of capital. They hit the jackpot.
Father Bernie was a big influence on the boys. “Dad was very hard-nosed about how he looked at numbers,” Joe said.
(The Feshbachs’ older brother, Dan, 42, chose not to join the firm and is chief executive of Mortgage Information Corp., a database service in San Francisco. Besides his two master’s degrees, he differs from his brothers by not being a Scientologist. “It works for them,” Dan said, “but it’s not my thing.”)
The other brothers credit Scientology, to which they donate great sums, for their skeptical, analytical style. “I willingly donate time and money (to Scientology),” Joe Feshbach said. “I think it’s the greatest thing that ever lived, and so do my brothers.”
In addition to contributing to the Church of Scientology and attending courses, the Feshbachs are members of the separate International Assn. of Scientologists, which promotes the church.
According to a publication of the association, Kurt and Matt are both “patrons meritorious,” having donated more than $250,000 each. Joe is a “patron with honors,” having given more than $100,000. Ten other Feshbachs have given more than $40,000 each, making the family’s total donations more than $1 million.
Feshbach Bros. employees are encouraged to become Scientologists, and many have. However, one former employee said Feshbach evangelism sometimes borders on coercion.
Another man who deals with the Feshbachs said the Scientology connection troubles him. “I think they believe Scientology got them where they are,” said the man. “I have to say that’s the aspect I’m least comfortable with.”
Although the Feshbach brothers and their staff dress casually, the office has a pressure-cooker aura. At the reception area, visitors are greeted with a sign: “We’re going to make Money!”
In an interview, Joe Feshbach’s eyes kept darting to the stock prices flashing on his computer.
According to Joe, Feshbach analysts are judged strictly on performance. Office walls are papered with graphs showing how many “new ideas” analysts have proposed to short, how their stock choices have performed and how the firm’s profit looks.
A misstep can mean dismissal, as with the employee who initially suggested shorting L.A. Gear.
It’s not all business, however. The Feshbachs, who are obsessed with exercise and weight, constantly tease one another. To torment his slightly pudgy, mountain-bike-riding brother Joe, Kurt, who could pass for a lean surfer in his shoulder-length, dark-blonde hair and tennis shoes, bought a candy-dispensing machine and installed it outside Joe’s office.
Given their recent stunning successes, it’s easy to see why the Feshbachs are acting like cocky kids in a candy store these days. Whether they can keep it up could be another matter.
But Joe Feshbach remains confident in their ability not to panic when others do.
“We don’t tend to make the same mistakes twice,” Joe Feshbach said. “Besides, we have a blast doing it.”
Times researcher Norma Kaufman contributed to this story.
How Short Selling Works 1. Anticipating that shares of XYQZ Corp. will drop in price, a short seller borrows 1,000 shares from a brokerage firm’s margin account and sells them at the current price, say, $18. 2. A week, a month or even two years later, when the price has dropped to a targeted point, perhaps $10, the short seller repurchases 1,000 shares and returns them to the broker. 3. The short seller pockets a profit of $8,000, minus commission fees paid to do the transactions.