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Can the NMC share price recover from Muddy Waters’ accusations?

It is very rare, and never good, to see a massive share price drop for a FTSE 100 company. By its nature, the blue-chip index should have constituents that are generally immune to such shocks. It was perhaps all the more surprising then, when healthcare operator NMC Health (LSE: NMC) saw its share plummet 40% this week thanks to a damming report from the well-known short seller Muddy Waters.

Should you listen to a short seller?

It has been my experience that the opinions of short sellers, while not always right, are always worth listening to at least. The truth is short sellers need to be more certain in their trades than the long side.

If you buy a share and it goes down rather than up, you can lose only your initial investment (assuming you are not leveraging), but when you bet on a price falling and it goes up, it can keep going up indefinitely, in theory.

Given NMC’s share price reaction, it seems many agreed with this assessment of Muddy Waters’ expertise.

Needless to say Muddy Waters’ did not release its latest report about NMC from the goodness of its heart. Even the best and most accurate analysis that leads you to open a short position only helps if the broader market finds out about it as well. However, the fact it will be making money from these trades does not mean it is wrong in its analysis.

The allegations

Muddy Waters took a broad and aggressive stance against NMC in its 34-page report, questioning just about every aspect of the company’s reported finances as well as its corporate governance. It even suggested that some of the numbers raise “questions about possible fraud and theft”.

NMC has of course offered a rebuttal against the accusations, though this has done little to help its share price. A number of very specific allegations are made in the Muddy Water’s report, and simply denying the assertions won’t possibly be enough to calm market fears until specific facts and figures can be shown.

What next?

Naturally the future of NMC largely relies on whether the allegations are true. If they are, then the company’s entire financial outlook will have to be re-evaluated by the market.

One of the specific concerns the Muddy Waters report raises is so-called off-balance sheet debt. The entirely legal practice usually involves borrowing money against future supplier payments, which, through the complex nature of accounting rules, does not get reported as debt on the balance sheet.

This does not bode well for NMC, as this practice (and activism from short sellers) was the downfall of UK outsourcer Carillion. I suspect NMC Health and its shares will be in for a very rough time of it in the next few months.

Allegations like this stick, and it takes a lot of factual evidence, as well as confidence from the market, to change people’s opinions. That is never an easy or quick process. The shares may be able to recover, but who can say when?

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Karl has no position in any of the shares mentioned  The Motley Fool UK owns shares of and has recommended NMC Health. Views expressed on the companies mentioned in this article are those of the writer and therefore may differ from the official recommendations we make in our subscription services such as Share Advisor, Hidden Winners and Pro. Here at The Motley Fool we believe that considering a diverse range of insights makes us better investors.