“We were kind of late to the party on German real estate dysfunction, but [Vivion] in some respects was low-hanging fruit, but unharvested, I think, because it’s credit as opposed to equity,” he said.

Asked if the decision to short a company with no listed equity was led by the rise of meme-stock traders, Block rejected the idea: “To be clear, we do [already] short credit, so we’re not switching our business model.”

Recall that, during the pandemic, retail meme-stock investors drove up the share prices of several near-bankrupt companies, including AMC, Hertz and GameStop, with some disastrous results for hedge funds short on those names.

For background on Muddy Waters’ report on Vivion, see 9fin’s recent coverage below:

• Vivion bonds tumble as short seller Muddy Waters takes aim
• Vivion principal shareholder dilution does not trigger CoC
• Vivion bonds rebound, but questions remain — Part One
• Vivion bonds rebound, but questions remain — Part Two

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Differences In Shorting Credit Versus Equity

Aside from the obvious differences in the liquidity of bonds versus equities, Block said that the relatively higher sophistication of credit investors is an important distinction to keep in mind when considering a short position.

“When I say that, the people in the credit world tell me how very few credit people are rocket scientists. And my response is: yeah, but have you talked to equity investors lately?”

From 2013 until late-2021, at least, equity markets participants “stopped being remunerated for caring about risk”, according to Block. “It became entirely driven by narrative. It’s different in the credit world, it’s binary, you either get paid or you don’t.”

While some narratives do resonate with credit investors, it is “not nearly as dysfunctional as it is in equities”. As such, credit short theses need to be all the more compelling.

“When you're talking about credit, and particularly when you’re talking about hard assets that underlie the credit, [the short thesis] does have to be profound, you do have to have a view that reality is significantly different from what perception is,” said Block.

By way of example, he points to French retailer Groupe Casino and its holding company Rallye, where — despite it being principally an equity short — Muddy Waters also took positions in the bonds and CDS.

“That’s something where it was so complex, and we said: they’re telling the market that their net leverage ratio is around three turns, or three-and-a-half turns. And no, it’s actually more like nine turns,” said Block.

“If you can find that level of delta between reality and perception in the market, then it makes sense for us to do something on the credit side, even if it’s purely credit. [But] just [a thesis of]: ‘I think these guys are going to get downgraded soon’ — that’s not a reason to short the credit,” he continued.

Although Vivion is its first pure-credit position, Muddy Waters has been comfortable with the concept of pure-credit plays for some time, according to Block. “We were working on Isolux, and we just couldn't get there before the credit imploded. That was back in late 2014, early 2015.”

Spanish construction firm Grupo Isolux Corsan was forced to restructure its €2bn debt stack in 2016, after corruption allegations saw the company’s bonds tank the year prior.

Muddy Waters built its reputations targeting Chinese companies with listed equity in the early 2010s — most notably Sino-Forest. More recently, its 2019 report on London-listed NMC Healthcare preceded the UAE-based health company’s collapse and takeover by creditors.

Public opinion toward short-sellers is mixed, with some market participants criticising them for talking their book, while others laud them as activist investors who keep companies honest.