LONDON (Reuters) - Some hedge funds are holding fire on Tesco in the wake of its accounting scandal and share price slide, with at least one fund cutting its short position as investors assess the potential for a rebound.
Although bearish bets on the world's third-biggest retailer have ticked up over the past week, short interest is down from its March highs. This suggests some speculative investors are reluctant to step up aggressive bets on a stock that has fallen nearly 20 percent in little over a week, is cheaply valued and may have turnaround potential.
There are still short-sellers out there; regulatory filings showed Tesco's largest short-seller, major hedge fund Lansdowne Partners, was sticking to a two-year-old "short" on the shares and major investor Blackrock reportedly reduced its stake in the firm.
But regulatory disclosures also showed hedge fund Lone Pine Capital has reduced its net short position on Tesco twice in the past 10 days, taking it to 0.40 percent of the company's share capital from 0.69 percent.
That followed billionaire Mike Ashley's bullish options bet disclosed last Thursday that shares in Tesco would not fall.
Fund managers said they were reviewing the stock in light of its inexpensive valuation - with its price at a two-year low relative to its expected earnings - and turnaround prospects under the new management led by Chief Executive Dave Lewis.
"I would not be short at these levels, and possibly consider starting to build a long position," said Lex van Dam, a hedge fund manager at Hampstead Capital.
Tesco said last week it said it had overstated first-half profit by 250 million pounds ($405 million), compounding existing concerns about its shrinking market share and sending its stock to an 11-year low - a 50 percent drop in just over a year.
Shorting Tesco has been a profitable bet.
Lone Pine is estimated to have made at least 19 million pounds on its Tesco short and is sitting on a further 26 million pounds of paper profit on that position, according to Reuters calculations starting on July 29, when the hedge fund disclosed its 0.5 percent net short position to the FCA regulator.
Short interest in Tesco, as measured by the proportion of its shares that are out on loan, has ticked up to 2 percent since it issued its latest profit warning but is still below its March peak of 3 percent, Markit data showed.
Short sellers borrow a security and sell it, betting they will be able to buy it back at a lower price before returning it to the lender, bagging the difference.
"It generally pays to wait until more information and more facts are there," John Hyman, head of equities at hedge fund Cheyne Capital, said.
Hyman cited Dutch supermarket Ahold and France's Carrefour as examples of two retailers which managed to turn around their fortunes after being hit by performance and accounting problems in recent years.
"Ultimately those things were ... satisfactorily resolved and it turned out that there was a great buying opportunity for the share market," he said.
Any turnaround is likely to need time and money, investors said.
Tesco is the worst performer of Britain's so called "big four" grocers, which also includes Wal-Mart's Asda, Sainsbury's and Morrisons which have all been losing market share to discounters.
The company is expected to have to cut prices to lure back customers, denting its profit margin. Furthermore, analysts are bracing for further write-offs on the company's accounts when Tesco unveils its interim result on Oct. 23 - the first time under new chief financial officer Alan Stewart.
"We need to clearly see the results of what's been going on in their accounting in the last few months (and) to know the strategy " said Simon Gergel, manager of Allianz Global Investors' Merchants Trust.
(1 US dollar = 0.6164 British pound)
Additional reporting by Vikram Subhedar and Liisa Tuhkanen; Editing by Lionel Laurent and Pravin Char