Liontown bid brings lithium armageddon upon hedge funds

*Burn all shorters* - story you can share with your kids over some acquired BBQ'ed taste


Liontown bid brings lithium armageddonupon hedge funds

Tuesday’s short squeeze in lithium stocks was one of the mostbrutal ever for hedge funds that took the other side of a popular retail trade.

Mar 30, 2023 – 2.12pm

Tuesday was a day of delirium for shareholders in ASX-listedlithium hopeful Liontown Resources after it received a $5.5 billion bid fromAlbemarle.

That bid, which was boldly rejected, was a 63 per cent premiumto the last closing price, prompting an even larger 68 per cent jump in the share price.

But in hedge fund land, it was a day of devastation.

A massive 63 per cent premium on the Liontown bid is not anoutcome many traders would have been prepared for.

The Australian Financial Review’s rough calculationsestimate traders lost around $300 million shorting five ASX-listed lithiumstocks in one ugly session.

Why? Liontown is one of the most shorted stocks on the ASX withabout 200 million shares, or 10 per cent of the free float, loaned out tospeculators. That makes it highly susceptible to a squeeze as the amount ofcapital seeking to close the trade might exceed the daily trading volume bymany times.

A short seller’s worst nightmare is to have short-sold stockthat emerges as a takeover target from a credible buyer.

The prospect of a takeover bid is a factor they have to acceptis always possible. But an announced bid typically does not exceed a 30 percent premium to the last traded price, even if it does ultimately go higher. Amassive 63 per cent premium is not an outcome many traders would have beenprepared for.

Spreading the pain

Hedge funds also typically spread their short bets if they’retaking a view on a sector rather than targeting concerns at a specific company.

But the fact that Liontown rejected the bid – which meant other targets could be in playand rallied accordingly – meant a diversification strategy could not spare thepain.

Heavily shorted lithium peers gained by double-digits, slugginghedge funds with losses.

Analysis based on the last available short selling data suggestsLiontown shorters lost $210 million on Tuesday, Pilbara Minerals shorters about$50 million, and bets against Core Lithium, Allkem and Sayona Mining were inthe red by about $15 million to $20 million.

Enthusiastic lithium investors, which include a large cohort ofretail investors, will no doubt feel nothing but satisfaction. There has alwaysbeen a large pile of money willing to bet against lithium stocks (hedge fundsoften line up against retail investors).

Ironically, the conviction on the lithium short had onlyincreased of late. The sliding lithium price as electric vehicle demand out ofChina waned logically suggested to hedge funds that the share prices ofAustralian lithium stocks would come under pressure.

Prime broker desks questioned why the Australian equity marketwas unfazed by what they regarded as a clear directional move in the underlyingcommodity prices as Chinese producersGanfeng and Tianqi struggled.

A further point of conviction was the sale by Chinese lithiumbattery manufacturer CATL of its stake Pilbara Minerals this year.

Liontown was the top pick for the shorts because it was in thetoughest part of its lifecycle as it graduated from concept stock to producer.

The company was a long way from first production and theconsensus is it would require additional equity to get there. When it did, theexpectation among shorts was that further lithium supply coming on market wouldonly work against, not for, the commodity price.

That was the thesis playing out in 2023. Until Albemarle camealong.

“Where equities are discounting too low a commodity pricecorporates will act,” said Jefferies analysts as they declared the beginningof an M&A cycle.

It’s not just short sellers that have been caught on the wrongside. Lithium stocks have become a bigger part of the small caps index buthaven’t been popular among institutional long-only fund managers either.

Those that didn’t own lithium instantly fell 2 per cent behindthe index on Tuesday, just days before they rule off March quarter performance.

So, the situation has set up intrigue for bulls and bears.

The confidence of Liontown’s management and its shareholdersthat it’s on the path to emulating another greatscourge of short sellers, Fortescue Metals Group, has only increased.

But the hedge funds that survived lithium armageddon may justsustain their bet that the best returns for the sector are in the past.