The denouement was worthy of a TV crime series.
With blue lights flashing, Italy’s Guardia di Finanza piled out of their Alfa Romeo squad cars on the outskirts of Bologna and stormed the campus of Bio-On. Pistol-toting agents rushed the offices of the bioplastics company, seizing files and documents. Stunned office workers looked on.
Across the Atlantic, Gabriel Grego breathed a sigh of relief upon hearing the news. As managing partner of New York-based Quintessential Capital Management, the Italian native had become a target of lawyers, media, and internet trolls since posting research months earlier accusing Bio-On of accounting fraud and lying to investors. He was wagering big-time that the stock would tank.
Much of the Italian press at the time rallied around Bio-On. Grego’s wife, Maya, was hit with obscene Facebook messages. Bio-On chief executive and chairman Marco Astorri filed a police complaint for defamation against him and then a criminal one alleging market manipulation and insider trading.
“I didn’t sleep properly for three months,” says Grego, decked out in a striped, blue Brioni suit, well-weathered Rolex watch, white shirt, and tie in a conference room in the Flatiron district of Manhattan. “The guy kept lying.”
“I was probably seen as the bad guy by 60 percent of them,” Grego adds, with the slight lilt of an Italian accent. “Until you are proven right, you are the magnet of evil. Then when the fraud is proven it’s, ‘Thank you, thank you, thank you.’”
Today, Grego stands vindicated. Astorri was arrested on orders of a Bologna judge on the same day as the raid, October 23. Trading in shares of Bio-On was suspended.
The company was declared insolvent in December. Bio-On representatives did not respond to a request for comment. Astorri faces charges of market manipulation and accounting fraud. In an email, his lawyer wrote: “Mr. Astorri claims his innocence against all the accusations that have been made against him.” Astorri stands by Bio-On’s technology, accounting, and communications, his lawyer added.
As a short seller, Grego points out that he rings up big-time profits by taking down malevolent market actors — but he gets plenty of satisfaction from the process too.
“My vision of improving the world is punishing the bad guy — and deterring the other bad guys,” he says.
That’s an exceedingly tall order in today’s markets, which are gyrating at a frightening pace. Opponents of short selling are sharpening their knives. And stock pickers in general are in ill repute. It’s a valid question whether Grego, in the age of coronavirus, is up to the challenge.
During the 11-year bull market in equities — during which short-biased hedge funds struggled, wheezed, and folded — Quintessential and its predecessor generated a return of 13.9 percent annualized from January 2009 through December 2019, according to a fund pamphlet, compared to 6.3 percent for the Hedge Fund Research long-short index. (This year through the end of March, Quintessential was down 12.8 percent, according to an investor, versus a loss of 13 percent for the long-short benchmark.)
Now, as the Covid-19 pandemic envelops the world, financial markets are in retreat — and the future of investors like Grego is more perilous.
In mid-March, regulators including those in Italy, Spain, France, Belgium, and South Korea unveiled rules to temporarily prohibit short selling. “This could devastate funds that get caught behind a short-selling ban,” writes Dan David, founder of short-selling firm Wolfpack Research, in an email.
Such short-selling bans typically prove damaging to markets and ultimately ineffective. “When the ban is lifted, some of these stocks initially thought to be helped by the ban will end up cratering,” writes David.
Nevertheless, an existential question is facing short sellers, value-focused managers, and perhaps the hedge fund industry overall: Are they even relevant in today’s quant- and index-driven stock markets?
The recent success of algorithmic and passive trading has pushed traditional active styles, long or short, back on their heels, leading increasing numbers of institutions to question whether they can even match their bogeys, let alone justify their fees.
Quintessential is evidence that they can, and that there is still room in the markets for an agile, independent-minded fund manager with a commitment to deeply researched investment tactics that cut against the grain.
“Gabriel has really developed a specialty in finding, researching, and exposing fraud,” says Whitney Tilson, editor of the Empire Investment Report and founder of Kase Capital Management, a hedge fund that he closed in 2017. “He’s not your typical short seller with a broadly diversified portfolio — he’s not short Tesla; he does in-depth research.”
Indeed, Grego has earned a reputation for expending huge amounts of man-hours to back up his theses — in the case of retailer Folli Follie, for instance, by cold-calling hundreds of locations and former employees to back up his hunch that its store count was hundreds less than it claimed. That turned out, in fact, to be the case.
He personally stalks his short-selling targets, poking his nose into factories and warehouses, often in dangerous parts of town in countries as varied as Jamaica and India, to suss out fraudulent businesses. “It can actually be dangerous work if you show up where criminal activity is taking place,” says Tilson.
The exhaustive approach is driven by a simple goal. “I like situations where there is a good chance of proving it without a doubt,” Grego says. “At some point, you smell blood.”
Nate Anderson, founder of Hindenburg Research, who has partnered with Grego on two occasions, has witnessed the process. “Part of it is his Socratic method — he’s trying to find holes in his thesis,” he says. “By the time he publishes, there is no longer any doubt about what is going on at that company.”
Grego’s exploits have made him a celebrity on the investing conference circuit, where his presentations, key to drumming up interest in ideas, are received with enthusiasm.
“I was just blown away,” says Anderson, referring to a 2017 conference during which he saw Grego present for the first time. “He had gotten out from behind his desk and gone around the world to prove his thesis. It made me almost jealous — it made me want to become a better researcher.”
The polished appearances of the telegenic Grego, whether at conferences, on YouTube, or on Bloomberg Television and other cable channels, undoubtedly benefit from the Dale Carnegie courses he has attended. His bona fides are further burnished in the testosterone-fueled world of short selling by the fact that he is a champion kickboxer, holds a black belt in karate, and is a former paratrooper in the Israel Defense Forces.
Even with less than what is reportedly $100 million in assets under management — a pittance, really — Grego and colleagues scour the world hunting for fraud. A January 2019 Quintessential pamphlet highlights investments from the different continents. It shows the fund earning a 100 percent return on its short position in Globo, a dubious London Stock Exchange-traded app vendor that Quintessential shorted in 2015.
The same year, Quintessential earned 50 percent shorting U.S.-based American Addiction Centers, which the fund nailed for insurance fraud tied to excessive urine testing. It also netted 70 percent on a short position on Israeli company Ability, whose phone call tracing software was fatally flawed.
Quintessential notched a 44 percent gain on Folli Follie, the Athens-based retailer that so wildly inflated its store count.
And Grego pocketed a 30 percent gain on Aphria, a Canadian cannabis retailer whose dubious management enriched itself through related-party transactions.
Grego, who describes himself as a value-oriented investor, also holds long positions (last year benefiting from Alphabet, Apple, Facebook, and Microsoft Corp.) and dabbles in minor activism and merger arbitrage — but admits “spend[ing] 80 percent of my time in activist short selling. You can’t be a master of everything.”
(There have been misses, including a 2014 long investment in California biotech company Gilead Sciences, whose opportunities for hepatitis C drug Harvoni didn’t pan out as investors had hoped. And in 2018, he unsuccessfully shorted Wirecard, a Munich fintech company whose accounting was widely criticized.)
Quintessential’s investors, a mix of institutional investors, wealthy individuals, family offices, and endowments, have pushed Grego to focus on activist short selling. In the fourth quarter of 2018, he launched a Pure Activist fund. It is intended to invest in one short idea at a time. A January 2019 brochure cites Quintessential’s stunning 61 percent annualized gross returns on its activist short positions since inception.
“Few people want to do this and subject themselves to the levels of stress, pain — and risk,” says Grego.
When he was 7, his family moved north to Italy’s financial capital, Milan, where his mother, Luisa, ran her own clothing store. His father, Claudio, worked for a spell as a lawyer at Republic National Bank, controlled by the Safra family, the fabled Lebanese-Jewish banking dynasty.
Edmond Safra, the patriarch, attended Grego’s bar mitzvah in 1988. It was shortly thereafter that the young Grego, overhearing a family friend opine that the Japanese yen was about to rise, plowed his bar mitzvah money into Sony Corp. stock — just in time to catch the start of Japan’s great recession.
“It taught me never to invest on intuition or because somebody gives you a tip,” Grego laughs.
From Milan it was off to Tufts University in Medford, Massachusetts. “It was full of smart, pissed-off people because they couldn’t get into the Ivy League,” he chuckles.
After graduation, Grego struggled a bit, working for a spell at what he describes as an undistinguished hedge fund in London.
Then, in 2000, Grego’s life path took an unlikely turn. A self-described Zionist, he volunteered for a one-year stint in the Israel Defense Forces, winning an elite position as a paratrooper. “It was a default,” he says. “I was not in love with economics.”
During the second Palestinian intifada, Grego was dispatched to the West Bank town of Sanur. Rocks and bullets ricocheted off Grego’s armored bus the night it approached the base for the first time, greeted by a pile of burning tires. “It looked like hell,” he says.
At Sanur, Grego bonded with comrades, though at age 25 he was the oldest of the 20 or so soldiers in his unit. “We called it the place that God forgot,” says Elie Isaacson, a fellow team member, who was impressed by Grego’s sangfroid. “He’s the only IDF soldier I know that would read The Economist during live fire exercises.”
With his age weighing on him, Grego left the IDF, heading back to Milan and Bocconi University, an elite private business school. He credits his paratroop experience with helping to form his research discipline.
“The feeling was you were training for the Olympics,” he says.
At Bocconi, Grego gathered a posse of friends, including Giovanni Patella, who recalled his classmate’s discipline. “He wants to be the best in his profession,” he says. Patella’s nickname for his friend: “One Shot, One Kill.”
Royal Dutch Shell provided Grego his first job after Bocconi. The oil giant was preparing to sell its gas stations in Spain and Portugal and was interested in figuring out which properties to invest in to fetch the best price.
“It was assessing value,” says Grego.
In 2004, it was off to suburban Tel Aviv, where he landed a post at Shrem Fudim Group, a financial conglomerate. There, he specialized in real estate and project financing.
By the summer of 2008, real estate and credit markets were grinding to a halt. Without work to do, Grego dabbled, investing his own portfolio. He even found time to study with Columbia Business School professor Bruce Greenwald, the value investing guru, in Munich.
In September, Lehman Brothers went bankrupt, his position was soon terminated, and what was essentially a dalliance — a collection of accounts he dubbed Zanshin Capital, financed by his father and friends — became Grego’s livelihood.
It was a good time to kick off an investing career. “I bought with the naivete of a value investor,” Grego says. “Things are cheap, I will buy.”
Early names included financial stocks like Wells Fargo & Co., American Express Co., and Berkshire Hathaway.
Zanshin remained long only, but post-financial crisis that was fine, generating a return of 39.2 percent in 2009, according to a pamphlet. Bank of New York Mellon contributed to the fund’s 18.9 percent return in 2010. And Microsoft bolstered the fund’s 32.9 percent gain in 2013, the year Grego overhauled his business as a hedge fund and rechristened it Quintessential.
Despite such results, the fund remains strictly bantamweight — a reflection of its roots in Israel, a backwater for hedge funds, as well as what Grego calls the trickiness of scaling an activist short-selling strategy: “I don’t want to do the mistake most hedge funds do, which is to grow the business too quickly.”
Apropos of the coronavirus, a 3M N95 respirator mask rests on the table. Grego doesn’t even glance at the flat-screen monitor flashing the market pandemonium.
“I was wondering whether it made more sense to watch the markets or ignore it altogether,” he muses.
Despite Grego’s affable disposition, the former paratrooper turns cagey on any topics that could be turned to his disadvantage by opponents.
Is the external affairs officer at Quintessential a relative? “How did you find that out?” he asks. A recent vacation destination? “I don’t want to give them any ideas,” he says. Okay, so how about the name of that favorite Manhattan sushi restaurant? “If you printed it, I wouldn’t be able to go there anymore,” Grego responds.
It’s enough to make you wonder why anybody would want to begin shorting stocks to begin with.
Grego’s first short wager was on Israel-based SodaStream International, which sells water carbonation dispensers and the returnable carbon dioxide canisters necessary to add fizz to the water. Following its successful 2010 initial offering, SodaStream’s dispensers were flying off the shelves by 2014.
Some curious figures disclosed by SodaStream, however, caught the former paratrooper’s eye. The ratio of returnable canisters being sold for each dispenser was declining, from from 8 to 1 in 2009, to 5.4 to 1 in 2010, to 4.9 to 1 in 2011, and 4.7 to 1 in 2012.
It was a smooth progression of numbers, but presented a problem. “I had no idea what it meant,” Grego says.
He had read the work of Jay Wright Forrester, a famed computer engineer and Massachusetts Institute of Technology professor whose discipline, system dynamics, harnesses computer simulation models to explore complex corporate problems, among others things.
A software application, Stella (for Systems Thinking, Experimental Learning Laboratory with Animation), allowed Grego to input the canister-versus-dispenser ratios into the program for analysis using system dynamics modeling.
The result: “The customer retention rates were declining,” says Grego. “The model said it was close to collapse.”
While people were enthusiastic about SodaStream’s carbonation system, they disliked buying and replacing the reusable canisters. Moreover, Google Trends showed that SodaStream was popular in only certain markets — those with superior water quality, a high degree of urbanization, and populations that had a high degree of concern for the environment.
In the summer of 2014, Quintessential opened a short position in SodaStream at about $45. The company soon issued downbeat guidance and ultimately reported a third-quarter earnings and revenue decline of 42.1 percent and 12.9 percent, respectively. Grego pocketed a gain of 20 percent or so, and closed out the position.
(SodaStream ultimately rallied, partly by expanding its geographic reach; PepsiCo bought the company in December 2018 for $144 a share.)
Since then, Grego has honed his short-selling techniques. He now seeks to purchase call options on his targets as a hedge in the event the share price turns against him. He gauges the liquidity of the target’s stock, a concern in many of the foreign markets Quintessential operates in. And he rolls out his short positions with slick presentations, TV appearances, articles, and published research reports.
One example was Globo, a London-listed maker of apps that let users tap into their companies’ servers using their own devices to access email, files, and schedules. By early 2015, bloggers had been grousing for some time about the quality of the Globo apps.
“I thought this was a nice starting point,” Grego says.
Quintessential’s own investigations showed the app froze repeatedly. Online reviews, too, were screamingly negative.
Globo claimed 3 million-plus users. Grego couldn’t confirm any customers and the IT heads of the companies he surveyed hadn’t even heard of Globo.
There were other red flags. Globo’s founder, Konstantinos Papadimitrakopoulos, had taken it public in 2007 via a reverse merger, not a traditional initial public offering. That’s a common way to avoid scrutiny when tapping the public markets.
But Grego was especially interested in Globo’s dubious financial statements. Net income, by his calculations, had been rising smoothly from 2011 through 2014, as had revenues. That year they hit €35 million (then $42.7 million) and €106.4 million, respectively. Yet free cash flow was negative in almost every period along the way.
Globo’s increasing capital expenditures, intangibles, and receivables meant it wasn’t generating cash flow from its profits, by Grego’s analysis. And indeed, trade receivables had nearly doubled from the previous year to €50.8 million.
Grego suspected Globo was using shell companies to pose as customers and generate false invoices that it booked as revenue. Other shells posed as suppliers, generating false expenses, which could be capitalized by Globo.
It was not a particularly innovative scheme. In the world of fraudsters, this is colorfully known as a “pork and pig scam.” The goal: Generate a fictitious, inflated income statement that Globo could use to obtain credit and issue shares, with hopes of eventually using proceeds to buy legitimate businesses.
The key to Grego proving his hunch was tracking down the bogus shell companies. Globo had a list of 40 distributors on its website. Grego called each of them. “Sometimes they didn’t exist. Sometimes they distributed detergent,” he says. “Sometimes they just hung up.”
Grego and colleagues set out to personally visit what they felt should have been the biggest distributors — in London; Kobe, Japan; Barcelona; and India. In no case were they able to confirm that the distributors were selling Globo’s products at all.
Next, since Globo wasn’t providing legitimate names, Grego plugged its three-color logo into a reverse image search to see what companies on the internet might possibly be linked to it. Two outfits, Metis and Darga, had Globo logos on their websites, prominently identifying themselves as partners. Grego believed these were almost certainly two of the shells used to generate Globo’s false sales and expenses.
Grego then flew to Athens, hoping to question employees at Metis headquarters. They turned out to be suspiciously located in a residential building just a nine-minute walk from Globo. There was no answer when Grego buzzed, despite the company’s claiming on its website to have 140 employees.
The scene was different in Manhattan, where Darga’s sales office was purportedly located. Grego arrived only to find the address listed on the company’s website was, in fact, in the landmark, stratospherically expensive Rockefeller Center. Not surprisingly, nobody in the Sixth Avenue skyscraper had ever heard of Darga.
Ultimately, Grego felt he had learned enough. “I make sure it’s 99.9 percent,” he says.
Grego compiled Quintessential’s research, including original documents, photos, and links, into a bulky, somewhat rambling 39-page report and posted it on his website on Thursday, October 22, 2015.
One person likely knew some of what it contained: CEO Papadimitrakopoulos, who sold 42 million Globo shares before the report hit, according to media reports.
The next day, Globo’s stock did not open on the London Stock Exchange’s AIM market. And on Saturday, at a special board meeting, Papadimitrakopoulos resigned, along with his chief financial officer, admitting to accounting irregularities. Globo’s shares were canceled altogether effective December 1, worthless.
An example was the run-up to Grego’s wager against one of the big retail success stories of the 1990s.
Grego recalls asking an investor friend about his position in Folli Follie, an Athens-based clothing and jewelry designer whose stores, numbering in the hundreds, had sprouted around the globe, but especially in China. Its profits had been making investors wealthy.
Folli Follie’s operating income had streaked 20 percent annualized from 2012 through 2016, the company’s most recently reported full-year figure at the time, to €257 million. Revenue had risen 11 percent annualized during that span to €1.3 billion. Asia, mostly China and Japan, had accounted for some 67 percent of sales.
But some investors, as Grego’s friend confided, had begun exiting the position for a curious reason: worries that Folli Follie was insisting on using a new, Hong Kong-based auditor named Chung & Partners, with just two partners, to audit its most critical profit driver, China.
Pressed on the matter in an earnings call, management claimed the change was for budgetary reasons, because Chung & Partners had agreed to do warehouse checks as part of their audit arrangement.
Grego did some back-of-the-envelope math. The family of founder Dimitris Koutsolioutsos controlled 40 percent of the Folli Follie share count. That was worth about $560 million. But shares were trading at a trailing price-earnings multiple of just 5.5, while competitors were trading at twice that. The prime reason appeared to be the new auditor, which was spooking investors.
Why, Grego wondered, would the Koutsolioutsos family insist on sticking with its auditors to save spare change when changing would double their wealth to more than $1.1 billion?
In his new office digs on Manhattan’s East Side, Grego used the online Folli Follie store locator to find the nearest location, hoping to glean insight from an in-person visit.
“They had a store at Madison and 57th,” Grego recalls, at the time happy that there was an outlet so close. He dashed down to the intersection — only to find that the Folli Follie had been replaced by another retailer.
The locator identified another store on Prince Street in the trendy SoHo neighborhood. He hopped on the local subway.
Again, there was no Folli Follie store. “I talked to the neighbors,” Grego says. “There used to be one a couple of years ago.”
Farther south, Grego finally hit pay dirt in the former World Financial Center. “There is a shop,” he says. “I bought my wife a purse.”
The salesperson confided that business was terrible: “‘This is the last store open in the U.S.’” This despite the company’s claim that it was investing heavily in the country.
Following his Manhattan pavement pounding, Grego and his team sprang into action. A colleague created a database to keep track of the Folli Follie stores worldwide. Grego began canvassing stores and their managers to verify their status and gauge the business activity they were seeing.
Managers described anemic sales. Employees complained about unfashionable merchandise, and mall owners cited Folli Follie outlets as among their worst tenants.
Quintessential zeroed in on the China market, which was generating all or nearly all of the retailer’s reported profits. Grego hired a Mandarin-speaking team to query stores there, interview managers, and report back.
The upshot: Of the 930 Folli Follie stores the company claimed to be operating worldwide, just 281, or less than a third, were operating.
A China-based contract researcher found a smoking gun — and perhaps the reason behind Folli Follie’s enthusiasm for auditor Chung & Partners. Filings with China’s State Administration for Industry and Commerce, generally the most reliable figures available, suggested that Asia had generated a mere $40 million or so in revenue for Folli Follie — a pittance compared to the $1 billion the retailer was claiming in its Greek securities filings for 2017.
It was the kind of disclosure from which no company is likely to ever rally back.
Quintessential released its report on May 3, 2018, when Grego pitched the idea at a Kase Learning investment conference. “Can the shareholders really believe the books here?” Grego asked. Folli Follie shares fell 30 percent, the maximum permitted on the Athens Stock Exchange, and then another 30 percent the next trading day. The stock was suspended three weeks later.
The bioplastics company billed itself as having a proprietary process to develop and manufacture polyhydroxyalkanoates, or PHAs, organic biodegradable polymers with potentially myriad uses.
The company was working at seemingly breakneck pace to monetize it, mostly through a series of joint ventures with established companies that would put the PHAs to work on everything from artificial bones to suntan lotion.
The skepticism was twofold.
First, though PHAs have been manufactured since the 1920s, they are devilishly difficult to produce in large quantities, as Bio-On claimed to do, because of the trickiness in using bacteria and other microorganisms in the process. Scientists doubted the company’s ability to follow through with an economically viable product.
Second, despite its status as a public company, Bio-On’s accounting was a black box. Looking at Bio-On’s financial statements, it was impossible to get a handle on what it was selling and to whom.
In March 2019, Grego was cc’ed on an anonymous email signed by somebody going by the name Tom Middle. “Due to questionable science and fake revenue, Bio-On’s equity is worthless,” the email read.
Around the same time, Bio-On released its 2018 financial results. Earnings before interest, taxes, depreciation, and amortization were €42.3 million on revenues of €50.7 million.
Grego figured he was ready to take on a challenge. But Bio-On was in fact a perilous hill to climb: With a market capitalization of €1.1 billion, it stood as a national sort of biotech champion. The company made up about a quarter of the capitalization of the Italian stock exchange’s AIM market, which caters to smaller growth companies. And the Italian economy needed some good news.
The numbers, however, backed up Grego’s suspicions. Unlike in the U.S., private companies and joint ventures in Italy are required to file financials with the Registro delle Imprese. These filings told a tortured tale.
Over the years, Bio-On had set up a series of joint ventures with larger companies, promising to, say, produce bioplastics from sugar beets, or incorporate PHAs into eyewear or textiles.
Each time, Bio-On, which retained control over the joint ventures, would issue a breathless press release promising, say, to invest tens of millions of euros in a plant. Prominent partners included Unilever and luxury-goods maker Kering. The joint-venture projects, however, would almost never get off the ground.
The joint venture would instead buy a patent or a license or two from Bio-On, which would book the payment as revenue. The venture wouldn’t pay a dime, and Bio-On let the account receivable sit on its books while never collecting.
Voila! Phantom financials.
Grego wrote as much in a Quintessential research report released on July 24, 2019. “Bio-On is actually a massive bubble based on flawed technology and ‘fictitious’ sales thanks to a network of empty shell companies,” he wrote.
The media-savvy short seller took to Bloomberg, YouTube, and Italian television to make his case, often in his native Italian.
Bio-On CEO Astorri likewise went public and then, going further, filed the civil and criminal complaints against Grego.
A Bologna prosecutor opened an investigation into both men’s allegations, worrying Grego: “It did concern me because it was a different magnitude of risk.”
Then came the raid — and the charges against Astorri.
Now that the battle is seemingly over, Grego has no regrets, and is on to researching his next short campaign. “Honestly, I would have done this for free,” says Grego. “The managers of these companies are corporate sociopaths.”
