A Horrid Landscape for the Negativists

 | Mar 12, 2014 | 7:09 AM EDT
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If you were to ask a short seller what the most dangerous words are in the lexicon are right now, he might say it's, "Our company is actively looking at ways to optimize our capital structure."

Those were the words that Pete Bensen, the chief financial officer of McDonald's (MCD), uttered yesterday -- and they drove a spike through the heart of anyone who was betting that numbers were simply way too high for the company and had to be slashed.

For the longest time companies just took it. They took the beating that came from disappointing performance. So same-store sales are down? That means estimates are too high. Estimates coming down? The stock gets hammered. So if you can predict who is going to disappoint for the quarter, then you can short the stock, and then cover when it disappoints, and numbers come down and the owners turn into sellers.

It really was that simple.

But now look at the landscape, just in restaurants. Wendy's (WEN) screws up repeatedly, and the next thing you know Nelson Peltz gets involved, and a new CEO gets appointed who is smarter and more shareholder-friendly. The shorts get crushed.

Darden (DRI) blows up repeatedly, missing estimates quarter after quarter. The stock becomes annuity for the short sellers, as you just need to short the common stock ahead of any report on how poorly Red Lobster was doing. The numbers get cut, the stock gets hammered and you cover into the weakness.

Then, suddenly, not one, but two activists surface. The next thing you know, the worse the news, the more likely something positive will occur, be it a change at the top or a genuine restructuring that brings out value -- not the inane spinoff of Red Lobster on an unsuspecting public.

Now McDonald's, after four straight months of disappointing numbers, comes out and says it might do something creative -- not with same-store sales, mind you, but with its balance sheet -- and the stock has its biggest rally in two years.

After all, the company is underleveraged, and it does have a lot of financial flexibility. Why can't it announce an even bigger share-buyback program or put through an immense dividend increase? Why doesn't it just close all the underperformers and shrink to grow? Or the company could split up the way Altria (MO) did, into a domestic entity that pays an absurdly high dividend with slow growth and a much faster-growing international business. Investors would love that.

But the short sellers won't. Which is what makes this market so difficult for the negativists. Activists seem to be lurking everywhere. Boards are listening to activists. Outsiders are demanding changes and they are getting them. CEOs get fired for missing numbers, and balance sheets get leveraged to boost stock prices.

It's all part of the 2014 landscape, and this phenomenon has been so unexpected that a now-serially underperforming McDonald's has become the best-performing stock in the Dow only a few days after it reported incredibly disappointing monthly numbers.

Short, miss the quarter, cut numbers, cover? No more. Now it is: "Get long, quarter's missed and action gets taken." No wonder hedge funds are doing so badly!

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