Under Armoured: Why We Shorted A Company That Didn't Protect Its Investors

Posted by Jerry Bowyer on 2/13/17 7:45 AM
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Last week, Under Armour stock crashed in value by 26%. This occurred when they announced that their holiday sales were less than expected (and holiday sales are very important for retail companies) and that next quarter's earnings were likely to be lower than previously expected. On the heels of that news, it the CFO of the company announced his departure for personal reasons.

This week, the company was rocked again by controversy because the CEO appeared on television and invited skeptics to 'look in my eyes…do you believe…this is a team that knows how to win!' (video available here: http://video.cnbc.com/gallery/?video=3000591848). In that same interview, he appeared to endorse President Trump saying that having 'a pro-business president… is a real asset for the country'. Given our hyper-politicized age, you will probably not be surprised to know that the latter statement has ignited a social media boycott firestorm.


Before the stock price collapsed last week, we were already, to put it mildly, not fans of the company. Our index, Vident Core US Stock Index (VCUSX) had UAA at a zero weighting. Our WeatherStorm Forensic Accounting Long Short Index (FLAGLSX) had a short position in the company. Why? It's not because we looking into Kevin Plank's eyes - it's because we looked into his company's financial statements. The eyes might be the windows of a person's soul, but the Balance Sheet, P&L and (especially) cash flow statement are the windows into a company's soul.


Here's what we look for in a company: A board of directors which works for the shareholder and a CEO who works for the board of directors. Companies like that split the role of CEO and Chairman so the CEO is not his own boss. Companies like that have board members without related party transactions, i.e. they avoid having board members who are in some way dependent on the management team which they oversee. Companies like that do not engage in the types of accounting practices which are fertile ground for financial shenanigans. I'm not talking only or especially about the illegal stuff, I'm talking about the perfectly legal but still misleading techniques that top executives use to 'manage' earnings reporting. This practice is called 'aggressive accounting', and it's a red flag. 


This is not to say that UAA or any other company with such accounting red flags are definitely issuing misleading reports. That's almost impossible to know until after the damage is done. When earnings reports eventually catch up with the company, certain characteristics indicate that management has greater opportunities for such practices and certain ratios help identify which companies are at greater risk for shareholders. The science of identifying such practices is called 'forensic accounting' and that science is what caused us to be skeptical about Under Armour.


The sort of things that stand out as red flags appear mainly in the zone of differences between revenues and profit which are based on cold hard cash flows as opposed to those coming from the world of GAAP earnings. Companies have a great deal of discretion in terms of the treatment of costs and revenues as they move from cash accounting to book accounting. Many acquisitions (or long term affiliation deals with outside entities such as UAA’s numerous pro-sports partnerships), accruals, etc. are red flags because they are zones of high managerial accounting discretion. Companies that have unusually differing cash flow and book earnings are red flags. Companies with earnings dynamics and pricing that indicate a higher probability of a value based on hype are a red flag.


UAA had a lot of red flags. Apart from the newer, much lower price, it still has those red flags. The firm is also at a relatively high risk for being subject to a class action suit. In addition, its revenue forecasting issues have led to the departure of the CFO 'for personal reasons', and a CFO departure during an accounting scandal is not a risk diminishing factor, even if you believe that they just suddenly wanted to spend more time with their families.


Mr. Plank's comments have added his voice to the welcome debate about whether President Trump is a pro-business president or not. My purpose here is not to answer that question. My purpose here is to say that one of the most pro-business assets which a country can have is CEOs who know deep down that they are just the hired help of the shareholders (or skeptical stewards who decide not to be shareholders), who don't depend on charm, momentum or high profile announcements of business alliances which are not matched by high performance.



Jerry Bowyer is Chief Economist of Vident Financial (www.videntfinancial.com) . Vident produces the Vident Core US Stock Index (VCUSX) mentioned above and its affiliate WeatherStorm Capital produces the Weatherstorm Forensic Accounting Long Short Equity Index (FLAGSLX). WeatherStorm Capital is a subsidiary of Vident Financial.

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