Jim Chanos, founder and CEO of Kynikos Associates, speaks at the Reuters Global Hedge Fund and Private Equity Summit in New York April 11, 2007.Eric Thayer/Reuters
When James Chanos bets against a stock, investors take notice. But his bet against CGI Group Inc. is by no means a sure sign that the Canadian technology company's shares are doomed.
Mr. Chanos, founder of Kynikos Associates, is famous for short-selling Enron Corp. before the energy trader went bust in 2001 and, more recently, his well-publicized belief that China's real estate sector is in a dangerous bubble.
Now, according to reports, Mr. Chanos has made CGI one of his largest short positions – a potentially intriguing bet given that Kynikos manages some $6-billion (U.S.) and CGI's market valuation is less than $11-billion.
The revelation alone has already had a big impact on the stock. In afternoon trading on Wednesday, CGI was down about 4 per cent in Toronto amid a spike in trading volume. That suggests investors want to get out of the way in a battle between a high-flying stock and a respected short-seller.
Mr. Chanos' short position comes at an interesting time. Despite being Canada's largest technology company based on market capitalization, CGI has long been a relative unknown, especially in the United States. But its profile rose considerably this year when it was tied to the failed launch of the Obamacare website, which CGI helped develop.
Mr. Chanos believes CGI's work on the project is a "PR mess" and could affect the company's ability to win future government contracts.
But given that the share price hit a record high as recently as mid-November, long after the company's association with the failed Obamacare launch had been widely known, his bearish case has to run deeper.
According to Newsweek, which obtained an undated 10-page memo sent to clients, Mr. Chanos believes the company also faces decreasing free cash flow, declining bookings of new orders and is using accounting conventions to boost earnings.
He could have also pointed to valuation issues. Although the shares trade at less than 13-times estimated earnings, the share price has surged more than 60 per cent in 2013, even after the recent decline. And it is up fourfold over the past five years.
During this latest runup, analysts at Desjardins Securities and CIBC World Markets have trimmed their recommendations on the stock to "hold" from "buy." And CGI's largest shareholder, Caisse de dépôt et placement du Québec, recently unloaded nearly 10 million shares, worth about $400-million (Canadian), saying the move was consistent with its "portfolio rebalancing policy." (It still owns more than 58 million shares.)
So its fair game to argue that CGI's shares no longer offer investors great value for the money. As for a compelling short-selling opportunity, the argument is less convincing.
For one thing, the PR mess over the Obamacare launch is unlikely to hurt CGI for long, if it hurts at all. The project was remarkably complex, CGI wasn't solely responsible and the problems are apparently being fixed.
After releasing its fourth-quarter results in November, CGI said that its "pipeline of new business opportunities continue to expand and remains active" – which was a direct response to the fallout over Obamacare.
CGI is also well diversified beyond the U.S. market. With its acquisition of Logica plc last year, it now operates in 40 countries in North America, Europe and South America, which puts the U.S. setback into perspective.
Mr. Chanos has gained a lot of respect as a short-seller for some big bets over the past decade, and investors seem willing to give him the benefit of the doubt for his call on CGI – so far.
But Wednesday's decline merely sends CGI's share price back to where it was in mid-November, and it has sustained four previous setbacks of 8 per cent or more this year alone, each time recovering to new highs.
A high-flying stock can be dangerous to buy. But it can be equally dangerous to short.
Follow David Berman on Twitter @dberman_ROB
Editor's note: A previous version of this blog incorrectly stated that energy trader Enron went "bust" in 2004. The year was actually 2001.