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For me, IFL does not trade in a fashion that suggests a large percentage of the short positions are for individual profit, or as part of a short attack on the share price (not at all).

Instead, I feel the bulk maybe made up of relatively non-threatening hedging positions (and probably not many are open as part of any strategy positions).

@Jako8557

As far as I know, the single largest short seller of IFL shares is LHC Capital; these guys have been short the stock for over four consecutive years now. Even though their entry point was significantly higher than the current SP (around 9$, conceivably), net of all the dividend payments they had to make along the way they are probably only marginally ahead P&L-wise.

The fundamental rationale for their short position is well summarised in the following excerpt (from LHC’s 2018 annual letter, courtesy of @thunderhead1 who originally shared this on 13/02/19).

“Short position: IOOF (IFL), Market Cap $1,880mIOOF (IFL) is a diversified financial services company. It provides financial advice, platform management and administration services, investment management products and trustee services to retail and wholesale customers.IFL has been a long term short for us, having first opened the position midway through 2015. The initial investment thesis, which comprises two parts, still holds today. Firstly, the underlying IFL business has been ‘ex-growth’ for many years. As such, IFL has relied on growth via acquisition to mask the lack of organic growth, whilst simultaneously cutting costs heavily and underinvesting in its core IT systems.

Secondly, we regard the IFL business model as structurally flawed. We believe there is an extremely clear conflict of interest for a provider of independent financial advice to consistently recommend the sale of investment products which they themselves manufacture over competing offerings. Fast forward to today and despite the equity having nearly halved, we have increased conviction in our IFL short. The company is facing unprecedented headwinds across all parts of its business, largely stemming from the two structural issues discussed above. The company’s platform business is exposed to fee pressure from incumbents with superior IT systems, whilst their vertically integrated strategy has been effectively labelled as “conflicted advice” by the Financial Services Royal Commission.

Furthermore, following pressure from the prudential regulator five of IFL’s business leaders (including the Chairman and Chief Executive Officer) have resigned, the company’s financial advisers are leaving the group en masse, and the firm’s brand has been irreparably damaged by the public briefings held during the Royal Commission. In addition to these headwinds, the company has dramatically underprovided for remediation, guiding for payments required for charging for bad or no advice in the range of $5 to $10 million. Macquarie research estimates the potential liability to be up to $608 million. With the company facing these headwinds, we see declining earnings and a forced cut to the dividend. IFL was a material contributor to the Fund’s positive return in 2018.”

So, overall, it would appear that the funds who are shorting IOOF are doing so because (right or wrong) they are convinced that the business model is flawed, not because such short position serves them as a “macro hedge” (or something along those lines).

Looking at the specifics of LHC’s short rationale, it is certainly true that earnings have been declining, and may not have found a base just yet.

On the other hand:

a) Vertical integration has not been abolished

b) There is a lot more clarity now on the amount of remediation payments

c) After the favourable judgement in the case with APRA, the reputational damage from the RC has arguably been reduced

d) FUMA has proved stickier than most had expected

e) The ANZ P&I deal (and with it future earnings growth) has now good chances of going ahead, possibly on improved economic terms

Therefore, given IFL’s current valuation (which is arguably already pricing in some further decline in earnings) and the ongoing cost of paying dividends, I see the case for shorting as being a lot weaker now.

Based on all of the above, I personally would have expected to see more short covering between the APRA judgement and October 17th (deadline for the ANZ P&I acquisition), but it is of course possible that those who are bearish the stock are still counting on the ANZ deal not going ahead. If that is the case, I suppose the re-rating in the event of a positive outcome will have to be amplified accordingly.

Cheers