“The Smell Test”: The Bear Cave’s Edwin Dorsey on Short Selling

Since developing a passion for short selling in college, Edwin Dorsey has developed a knack for identifying bad businesses. From predatory billing strategies to negligent safeguarding, he talks OPTO Sessions through some of the most eye-catching cases he has covered on his Substack newsletter, The Bear Cave.

Edwin Dorsey is Founder and Author of the influential short selling newsletter The Bear Cave, as well as the publisher of the Sunday's Idea Brunch newsletter.

“I’ve been passionate about the stock market from a very young age,” he tells OPTO Sessions. Despite an early fascination with Warren Buffett during college, his passion for stocks developed into an interest in short selling.

“I got introduced to two of the biggest people on the short side: Marc Cohodes, an independent short seller, and Jim Carruthers, who ran a billion-dollar short-only fund called Sophos before scaling back in 2021.

“They became my early mentors in college, showing me the ropes and how to dig into companies.”

After his first year of university, Dorsey was alerted by a friend about some suspicious activity at babysitting website Care.com. Applying what he had learned about due diligence, he began investigating the company while still a student at Stanford University.

After successfully creating an account as convicted sex offender Harvey Weinstein, Dorsey realised that Care.com was “claiming to do background checks, and in some cases charging parents for background checks, but they didn’t appear to be actually doing them”.

Dorsey’s investigation led to a two-year “war with the company” and an exposé by the Wall Street Journal, which cited him and documented several tragic instances of negligence by Care.com. The 2019 article revealed that approximately nine caregivers with criminal records were listed on the site in the preceding six years; several children had died while under their care.

“That gave me the credibility I needed to eventually launch my newsletter, The Bear Cave, that now focuses on the same type of corporate misconduct.”

Dorsey believes that “the best short sellers have a passion” for identifying bad businesses. His mentor Cohodes “likes to say it’s a genetic defect, to hold people accountable.

“There’s a lot of easier ways to make money in the market than by being a short seller.”

Gut Calls

With The Bear Cave, Dorsey sets out to be a qualitative rather than quantitative source of information.

“I don’t give price targets. I don’t short it myself. I really just say, ‘This is what I’m good at, this is what I’m going to focus on, and I’ll let everybody else do the rest.’”

Given this qualitative focus, and the length of time that he has been writing The Bear Cave, Dorsey usually finds himself trusting his gut. He gives the example of Chegg [CHGG], a student learning platform that Dorsey believes is having its core business model disrupted by artificial intelligence (AI).

“You go to TikTok and there’s tons of products competing with Chegg. You read the comments and all the students are saying ‘I can't wait for Chegg to die, they screwed us, I hate Chegg.’”

Dorsey went through the company’s cancellation process himself. He describes it as labyrinthine, with tricks including changing the button that needs to be clicked to continue midway through the journey.

This combination of persistent complaints, manipulative practices and increased competition is a sign that Dorsey now picks up on intuitively. He published his article on Chegg on 4 January; the stock has fallen 73.7% in the time since.

DeFinitely Risky

DeFi Technologies [DEFTF] is, Dorsey says, an extremely complicated company.

“If you tried to figure out what they do from their website or investor presentation, I think you’d be left very confused,” says Dorsey. “I was very confused. After hours of trying, my best summary of it is they’re a conglomerate with various different crypto assets.”

The most valuable of these — the “meat and bones” of the business — is Valour, an asset management company that issues exchange-traded products (ETPs) based on the performance of ‘altcoins’ — second-tier cryptocurrencies such as solana or dogecoin. The company makes money by charging fees on these ETPs, as well as by lending or staking the coins that are held in them.

The first thing that caught Dorsey’s attention was a rapid increase in DeFi’s share price. In 12 months to 17 June 2024, the stock went from $0.06 to $2.26 — gains of 3,667%. He also noticed that the stock was attracting extensive attention on social media. Both are initial red flags as far as he is concerned.

He then read an article via the online publication CoinSnacks that exposed ties between DeFi and stock promotion firms. Crypto investor Anthony Pompliano wrote two articles praising the company. All of this aroused Dorsey’s suspicions, and he started to dig further.

“Immediately, stuff started to not make sense. I saw that the company had a lot of ties to previous failed ventures. And that’s what made my ‘spidey senses’ go off.”

The executives’ previous businesses were in unrelated industries such as cannabis or gold mining.

DeFi’s registered address was also shared with several failed businesses in unrelated industries.

“I wonder what this address is. Maybe it’s a huge building, and they’re just big offices. So I looked it up in Google Maps, and it’s this tiny little shack, and the exterior is a trading card business that sells Pokémon cards.”

On one level, he feels that Valour could represent a viable business model. However, he believes that there are significant risk factors — such as regulatory risk, or the possibility of losing the coins that its ETPs own — that its management is not disclosing and that investors are overlooking.

“It just doesn’t pass the smell test.”

The biggest issue for Dorsey, however, appeared when he noticed to whom the company was lending its altcoins. DeFi’s filings kept the names of the eight anonymous counterparties hidden, listing them simply as Counterparty A, Counterparty B, and so on.

“This is very, very risky”, says Dorsey, despite the claims of DeFi’s advocates that there is little to no downside risk about the stock.

“If there’s no risk, why are there eight anonymous counterparties? If there’s no risk, how are you earning above-market returns?”

Knowing When to Stop

The temptation for someone in Dorsey’s position is to continually write on ‘bad’ businesses, but he tends to stick to a single article for each one. This is as much about self-preservation as anything else.

“I’ve never been sued. I’ve only got a cease and desist once. Care.com went out for me a little but they never sued me.”

Cohodes, however, has a less cautious approach.

“He’ll say ‘I’m going to send the CEO to prison,’” says Dorsey, who is wary of that approach himself. “Even if you’re completely right, they’re obviously going to fight back.”

Usually, Dorsey will move on after publishing a single article on a given company, being content to put his thesis out and let investors decide for themselves.

“I’m just looking to do my research, share my article on the market and let the winds of our universe blow and maybe shift things a little more in the right direction.”