In the wake of the U.S. subprime crash, the beleaguered automobile industry seems the most likely to stumble. General Motors Corp. and privately held Chrysler, hampered by their large financing divisions, quickly went to Washington for help. Ford Motor Co., in better shape than its Detroit competitors but still feeling the pinch, was along for the ride. But for hedge funds — especially those focused on equities — finding winning trades in the troubled car industry has not been easy.
The perils of investing in the sector were underscored late last year, when a short squeeze on Volkswagen’s stock hurt many portfolios. Shorting the German car company was a popular trade. But VW’s share price soared from €211 ($271) on October 24 to €945 just five days later, after rival Porsche announced that it had amassed a 74.1 percent stake in the company through equity and options, leaving only 4 percent of shares available on the open market. Investors with short positions were forced to cover, and many hedge funds suffered significant losses. Among those hit were Stamford, Connecticut–based SAC Capital Advisors and New York–based Greenlight Capital and Glenview Capital.
The Volkswagen fiasco has scared many hedge funds off of the car industry, and the political situation isn’t helping. Although the Democrats now control the White House and have strengthened their majorities in Congress, little consensus remains on how and if government support of U.S. car manufacturers should play out.
And the bears continue to roar. “We shorted everything to do with domestic automobile stocks the day we opened for business [in 2004],” notes Ronald Glantz, a partner at San Francisco–based $1 billion global macro hedge fund firm Pantera Capital Management. His fund continues to hold a negative view of the U.S. car industry. Shorting isn’t so easy because of the scarcity of GM and Ford stock. The rebate demanded by owners of GM to borrow their shares can be as much as 100 to 120 percent of their value, on an annualized basis, and that’s only if the shares are available. Part of the problem is that GM and Ford issue convertible debt, which means arbitrageurs have already borrowed many of the securities.
One alternative to shorting auto stocks is to buy credit default swaps and hope the industry goes bust. But CDS contracts pay out only in the event of a bankruptcy, and it’s uncertain whether a government-overseen restructuring would qualify. Using credit default swaps as a proxy for going short could be disastrous if such a restructuring wasn’t considered a bankruptcy.
A safer play may involve shorting parts suppliers or auto dealers. One potential target is AutoNation. The Fort Lauderdale, Florida–based company has 239 car dealerships, significant exposure to GM in particular and a market cap of $1.58 billion. Its shares have fallen more than 50 percent since the beginning of 2007, trading in mid-January at about $8 apiece. But even those shares may be difficult to borrow, as Edward Lampert’s Greenwich, Connecticut–based hedge fund firm ESL Investments owns about 44 percent of AutoNation.
Still, some hedge fund managers say they remain optimistic. For them, Ford’s recent $3 share price looks cheap (hedge fund firm SLS Global in New York and Los Angeles–based credit and distressed specialist Canyon Capital Advisors have stakes in Ford).
And even GM has its fans. New York–based Tiger Global Management, headed by Charles Payson Coleman III, reported owning 4.5 million GM shares in its most recent regulatory filling.
