Monday, May 9, 2011

The Steve Madden counter example

Steve Madden - the designer of the ridiculous high-heeled shoes beloved by teenage tarts - gives me nightmares.

And every time I go to my office in Bondi Junction (Sydney, Australia) I pass - at the entry foyer - a far-flung outpost of Steve Madden Shoes - a reminder of the risks in my business.

I short stocks - and whilst I carefully examine the accounts and sometimes even stake out factories - mostly I find shorts based on people. Brokers and stock promoters with a history of fraud interest me. Lawyers are my favorite of all scumbags because some do the documentation for fraud after fraud after fraud and lawyers seldom get pinged. Stock promoters come-and-go. Lawyers are eternal!

I will short a stock (in very small quantity) based on an association with one suspect lawyer and one suspect promoter. I read the accounts if the stock goes against me - and depending on what I find I either increase my position or cover. If the stock just goes down (which it often does) I just take the profits and wish I had shorted more.

When one goes against me I think - yet again - of Steve Madden and his tarty shoe company. Steve Madden is my eternal nightmare.

But for that you need some background

Stratton Oakmont and Steve Madden

Stratton Oakmont was arguably the most fraudulent stockbroker ever to operate in the United States. Its founder (who went to prison) wrote about it in agreeable first person: The Wolf of Wall Street is a tale of high class hookers (known as "Blue Chips"), Quaaludes and stock fraud. 

Every stock taken public by Stratton was a disaster and a fabulous short. They all crashed and burned. Every stock that is except one.

The except one is Steve Madden Shoes (SHOO:Nasdaq). And even that was a close-run thing.

Steve Madden was a small-time shoe designer going nowhere and frustrated with his lot working for larger shoe companies. He struck out on his own. 

But he had no money - so - in the great tradition of America - he went cap-in-hand to Wall Street. 

But he did not just go to Wall Street, he went to his childhood friend Danny Porush. 

Danny was senior at Oakmont Stratton and Steve Madden shoes was dressed up in classic Stratton fashion. In other words the company was over-promoted (even fraudulently promoted) and the stock was manipulated. Jordan Belfort (the CEO of Stratton) had large undisclosed positions (he admits this in his book) and was actively involved in the manipulation of the stock.

Eventually the manipulation scheme comes crashing down. Steve Madden is charged with stock fraud and pleads guilty. He went to prison.

Something strange happens on the way to the stock manipulation

Usually this is the profitable end of a fraud-short. Usually, but not always.

Something strange happened on the way to the stock fraud. That something was Steve Madden. Madden always was first-and-foremost a shoe designer and an outrageous and outrageously successful one. Even by the time Madden was charged Steve Madden Shoes was on its way to being the most successful high-heel shoe company in the world. Teenage girls just love him.

And Madden - from prison - retained his role as design guru for the company. Beyond prison he is back in the saddle - and the success continues. The stock goes up because Steve Madden is good at what he does. The stock is a 25 bagger.

This is a lesson to me

I see fraud in accounts regularly enough. There is no trouble finding fraudulent companies and if you picked Steve Madden as a short you had indeed found a fraudulent company.

But it hardly helps. The money raised by stock fraud at the beginning of Steve Madden Shoes nourished the growth of a truly successful (and valuable) business.

Shorts - and there were plenty of shorts - had a really bad time with this one.

Every company I short I have to ask myself - even if I am sure this is dodgy - how do I know I do not have the next Steve Madden? To me that is the stuff of nightmares.

And here - just to rub it in - is a picture of Steve Madden with Katy Perry. Not only did he get the loot - but he seems to have got the girls as well.

As a shortseller photos like that just rub salt into wounds.



AC said...

There's no accounting for bad taste...

(I know it's an awful joke, but still - it had to be said)

On a more serious side, the fashion business is so fickle that anything vaguely popular would be difficult short. Lululemon is an example.

Anonymous said...

Yes, I guess it is the reverse of Munger's comment that: "If you mix raisins with turds, they're still turds!".


John Hempton said...

I was thinking of the turds and raisins comment. I think Charlie is flat wrong.

You mix enough raisins with the turds and it winds up as a tasty dish.


John Short ad sinorazum said...

Wait what? So a guy who admitted pumping a stock discovers he has a hidden talent in shoe-making and turns into a world renowned shoe designer making his company super succesful? Is that even possible?

John Hempton said...

John Short. It happened.

If you had understood his stock frauds (which he admitted to) and had only a minor understanding of teenage fashion (I have none at all) then you would have been rolled over as a short.


Jeff Matthews said...

Best opening line of any blog I've ever read. And wise words.

Anonymous said...

So, dumb question: At what point did you figure out that you had to get out? (What indications told you after the fact that this was going to be an unprofitable short)?

But What do I Know? said...

Great story, JH! Kind of reminds me of The Producers.

Maybe you could call those heels in the first picture Black Swans. . .

John Hempton said...

I was never short the stock... but the shorts seemed to lose 4-6 times their initial stake.

I ask myself - given my risk control rules - what is the maximum I could have lost if I was dumb or unlucky enough to wander into this... and it comes out at about 4.5 times the initial stake. But our initial stakes are VERY small (as described elsewhere).

The strange thing - when the company was floated the private value of the company (if you were to negotiate a private sale) might have been 10 percent of the stock price. It would not have been a bad "valuation" short. But the "cheap company" can discover something - a new process, a drug, a better shoe marketing model...

And that is what happened here.

The company was not "worth" 50 million when floated. It made that value well after IPO rather than before it...

Still a salutary lesson for short sellers...

Anonymous said...

Wow, four and a half times!?! That takes some cojones; usually a 30% loss on anything but options makes me think I screwed up somewhere along the way.

But then, I don't short too often either.

BTW, Citron put up another Longtop post. Very interesting stuff.

John Hempton said...

There is a reason why our shorts are numerous and small. When you get one wrong it REALLY hurts.

So far we have not had too many errors (and our short-returns are off-the-scale good) but it will not always be that way.

Its gonna be bad for one one day. I will get my Steve Madden.

Solution: do 50 plus - all small - and then one bad one is not going to matter.

The losses of 4.5 times your initial investment is a real short disaster - but if your initial position is 1 percent - and you lose it over two years it hardly matters. Really...

Our longs are often 7-9 percent of portfolio - so getting a long wrong hurts more even though we can only lose the initial investment.


Anonymous said...

JH: The company was not "worth" 50 million when floated. It made that value well after IPO rather than before it...

In my mind, that's how Google turned out (although it was never fraudulent, of course). I was laughing at the people who bought the IPO and secondary share offerings, thinking it was laughably overpriced (and I still believe it was overpriced bac then). Given the way it's developed, though, my even pessimistic estimates put it at about 30% underpriced (of course, I'm just a complete amature), so what do I know).

Unfortunately, it just took me a long time to realize how wrong I was, though...

John Hempton said...

You were wrong about Google on listing and so was I. I was just not that familiar with the build-the-traffic-then-build the revenue model.

It goes to what Facebook is worth. It has built the traffic. Revenue is a little slower.

But the traffic volume is so large that I think the revenue is a cert.


At Google and Facebook there was something there before the revenue.

At Steve Madden the only thing really there was Steve Madden...

There is a difference.


Anonymous said...

But the traffic volume is so large that I think the revenue is a cert.

That's great, but how do you even guess at the amount of revenue and the probability of generating it?

As a superficial comparison, Murdoch tried to monetize Myspace, and I think it's self evident that that didn't go over too well. On a much smaller and more targeted scale, the New York Times and at one point the FT and Economist also tried the traffic valume to create revenue, and they've all since retreated from that model, albeit in a very clumsy way.

Even with Google, it's a lot easier to look at Android and determine that AAPL is going to get hammered than it is to get a good fix on how Android will contribute to Google's value. As for the "peripherals"--I assign a $0 to Google TV/Google Voice, Google docs, cloud computing, for example. Is that a good assumption? Will Facebook evolve to take over the YouTube segment? Beats me...

As for "the only thing for Steve Madden's shoes was Steve Madden"00isn't that a little like saying that the only thing Berkshire originally had going for it was Warren Buffett? I mean, one dedicated guy with a lot of talent can really do wonders, sometimes. Presumably, that's why investors try to talk to management.

Anonymous said...

John, you have mentioned in the past that you have contacted regional offices of the SEC. Are they at all receptive to investigating situations where the same lawyers and / or promotors "with a history of fraud" are involved? Do they have any pride, or do they just not care?

John Hempton said...

The SEC is a large bureaucracy. There are good people there. There are incompetent people there. There are venal people there.

If you get the right person in the right regional office and they are not swamped under you can sometimes get a little action.

Generally - you might as well drink a beer and watch the footy.


Anonymous said...


what are your thoughts on stock promoters not doing due diligence on the IPO that they are bringing to market?

First, it was China Forestry, now it is Longtop.

bidrec said...

Steve Madden had very clever advertisements posted in the NYC subway, photo-caricatures of a sort.

If you can run in his shoes to catch a train then they are good shoes.

If females riding the subway in NYC were his sole customers he would have made money.

Anonymous said...

Shoo is trading at over 200x it's ipo price. The stock being overvalued a bit at the offering or traded aggressively by the underwriter won't mask growth and earnings for long

John Hempton said...

It is two times sales - which is aggressive - but I am not sure why you think it is an obvious short now?


Steve Sailer said...

Here's Manolo the Shoe Blogger on whether Steve Madden is a great shoe designer or a great copier of great shoe designers:

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