David Einhorn appeared on Consuelo Mack’s WealthTrack program on November 19, 2010. If I can locate the video, I will embed it here. Until then, I have attached the transcript:
Consuelo Mack WealthTrack – November 19, 2010
CONSUELO MACK: This week on WealthTrack, the financial sleuth-hedge fund manager who identified the gaping financial holes in Lehman Brothers, Allied Capital and the financial system at large. Where is he seeing strengths and weaknesses now? A rare interview with Greenlight Capital’s David Einhorn is next on Consuelo Mack WealthTrack.Hello and welcome to this Great Investor edition of WealthTrack. I’m Consuelo Mack. If you are looking for a morality tale about the financial crisis and the long trail of its aftermath, which we are still navigating, I think we have found just the ticket. It is the updated version of hedge fund manager David Einhorn’s 2008 book, Fooling Some of the People All of the Time: A Long Short (and now Complete) Story. Only this time, its new title reads Fooling Some of the People All of the Time: A Long Short (and now Complete) Story. And complete it is because the financing company Einhorn shorted, ultimately successfully after 7 long years, is no more. Suffice it to say, as you can see from this stock chart of Allied Capital, it was a harrowing ride. A roller coaster from 2002 when Einhorn’s firm Greenlight Capital started shorting its shares, to 2007 when the stock went into a free fall But that’s not the half of it. In the process, Einhorn was, as he describes it, “attacked by the company, vilified by the press, and investigated by the Securities and Exchange Commission.” And that’s the mild stuff.As you will see in just a moment, it takes an unusual individual to be a successful long investor, let alone a successful short. David Einhorn is both: summa cum laude graduate of Cornell, world class poker player, co-founder of value-oriented hedge fund, Greenlight Capital in 1996, when he was still in his twenties. And Greenlight has delivered greater than a 21% annualized net return for its partners since its inception by mostly buying companies long, but making its reputation shorting stocks in a very public way. One of its most heralded shorts was Lehman Brothers, another bruising, albeit much shorter battle. As for the morality tale, Einhorn believes the Allied Capital saga has a meaning far beyond the company. He says it represents what’s still wrong with the entire financial system. I asked him for some specifics.DAVID EINHORN: The basic problems were that you had accountants that weren’t doing proper oversight. You had the SEC, which was not doing proper oversight. So you have rules on the books that are not actually being enforced. You have a management team that is being dishonest. And you have all of the support network, which is supposed to actually be sort of a watch dog, actually enabling it. So you have Wall Street analysts touting management’s side of the story. You have the financial media taking on their sound bytes and adopting them as just the way that things ought to be. And so you have this entire sort of breakdown in terms of watch dogs, and then cheerleading section that is actually enabling the bad behavior to persist, ultimately to the detriment of the people who are supposed to be protected, which were the investors.CONSUELO MACK: Has anything changed? Are any of the watch dogs doing their job better?
DAVID EINHORN: Well, the truth actually is, what we’ve seen is, even in the bigger financial crisis, the same watch dogs have just repeated the same behavior, just in a much bigger way. So what we’ve seen, the same kind of sort of forbearance towards Allied Capital has been granted to the big banks, the big investment banks, and so forth. The credit rating agencies, which did such a bad job with a subsidiary of Allied Capital, we now know that they did such a horrible job, perpetuating the whole crisis, and quite honestly, even though we passed a financial reform bill which is longer than a telephone book …
CONSUELO MACK: Right, 2,000-some odd pages, right?
DAVID EINHORN: Yes. It doesn’t actually address the obvious things that came out of the crisis that a common sense person would say, we need to simply fix them.
CONSUELO MACK: So what do we need to fix?
DAVID EINHORN: Number one is, we shouldn’t have credit rating agencies in any form. Even in their best, they add to cyclical pressures. They say positive things when things are good, that restores confidence; and then when things start getting into a crisis, they actually exacerbate the crisis by now saying that things are bad. Another thing that needs to be changed is, we learned that the money markets are unregulated banking institutions without reserves and without regulation, such that they can’t suffer even the smallest amount of loss. That was the big fallout from the Lehman crisis, was when the money market started appearing to have runs on them. And …
CONSUELO MACK: And a couple broke the buck.
DAVID EINHORN: That’s right. And soon the investors there, they basically believed that the buck could not be broken, and so the whole system was going to collapse around that. And that remains very much in place today, with all of that same risk. Number three, we learned that big financial institutions, if they’re so big, and you allow them to fail, they’re going to have domino effects.
CONSUELO MACK: So even with what we’ve seen, with the banks being more prescribed in what they are able to do, I mean, using much less leverage, being more scrutinized, you don’t think that that’s enough?
DAVID EINHORN: It’s just not enough. If you look at the big banks, they’ve gone from maybe 25 or 30 times leverage to 15 or 16 times leverage, or something like that. That’s still a lot of leverage. And it doesn’t count the derivatives books. And you have these huge notional derivatives books that, they’re just sort of tail risks that are sort of out there, and nobody really knows what’s in them, and nobody knows what risk they pose, and you certainly know that if any of the big four or five books that have the massive derivatives books was going to be on the cusp of failing; you would need to bail them out, the same way, in the future, that you would in the past. Notwithstanding whatever the new rules supposedly say.
CONSUELO MACK: So as an investor listening to you, would you touch a bank with a ten foot pole? At this point, would you invest in one of the major money center banks?
DAVID EINHORN: No. We wouldn’t invest in the major money center banks.
CONSUELO MACK: In a recent letter to Greenlight Partners, which, for those of us who don’t own hedge funds, means investors, you wrote– you were very critical of the Federal Reserve, and the most recent round of quantitative easing. And not only do you doubt it is going to be successful, but you also think that it could actually be harmful. Why?
DAVID EINHORN: Well, I think it’ll be harmful for growth, right away, if the purpose of the quantitative easing is to ease financial conditions, thereby, according to the Fed Chairman’s op-ed, make the stock market go up, make some people feel wealthy, and then go out into the stores and buy things. That’s offset by the fact that they’re trying to create inflation. And the may not get the inflation where they want. They’d love the inflation to be in house prices. But they might get it instead in oil prices. Or cotton prices. Or food prices. And there’s already a lot of evidence of this. The problem is that those prices affect a large number of people who have to buy these sort of necessities of life.
CONSUELO MACK: Food and shelter.
DAVID EINHORN: Food and shelter, and …
CONSUELO MACK: Right. Energy.
DAVID EINHORN: … clothing, and energy. And if the prices of those things go up, they’re not going to have as much money to buy other things. And so you may actually not get any increase in demand. You may actually slow down economic growth. And that is separate and apart from the longer-term ramifications of going through a process of effectively money printing, buying, creating electronic money to buy Treasury securities, which is what the so-called quantitative easing ultimately amounts to.
CONUSLEO MACK: Now, one of the things you just mentioned is inflation. And we are seeing inflation in hard assets. And one of the hard assets that you own at Greenlight Capital is gold. It’s your largest position. So what does gold represent to you, in your portfolio?
DAVID EINHORN: To me, gold represents money. And there’s different types of money. Some people think gold is a commodity, and they want to think about jewelry demand, and how many weddings there are in India, and so forth. And how much is coming out of the ground. I think of gold as money. And you can have dollars, or you can have Yen, or you can Euros, or you can have Pounds, or you can have gold. And there’s other currencies in other countries, but those are the sort of the major currencies as I see it, and I think that the merit of gold is, given our current monetary policy and our fiscal policy, as well as the problems in the other major currencies, gold is the money, I think, of choice, that we would like to have a meaningful amount of our assets denominated in.
CONSUELO MACK: So how meaningful an amount do you have?
DAVID EINHORN: We haven’t really said. But it’s the biggest position in the fund.
CONSUELO MACK: For individual investors, who don’t have the kind of flexibility that you do to trade and, nor the sophistication, I mean, how should we view gold, as individuals? I mean, should it be in all of our portfolios? And should we, too, view it as a substitute for paper currency?
DAVID EINHORN: I think so. I think it makes sense as a diversifier, and to have this sort of money, particularly because this is the kind of money that Chairman Bernanke can’t print more of.
CONSUELO MACK: You told me that your grandfather saw the debasement of currency coming really early on in the 1970s. What did he see that worried him so much, and what is it that still worries you today, and it’s the Einhorn heritage?
DAVID EINHORN: Well, I don’t know if it’s a heritage, but from the time I was probably a teenager, my grandfather wanted to have the gold talk with me. So that’s kind of like a family thing. In fact, he wanted to have the gold talk with everybody. Because…
CONSUELO MACK: He was a gold bug.
DAVID EINHORN: He was a gold bug, absolutely, he was. And frankly, after hearing about it and thinking about it for a while, I really was a nonbeliever. He kind of predicted, eventually what would happen, eventually there being inflation, eventually the government would print too much money, so on and so forth, and he decried the deficits and the entitlements and all the things that are coming more into focus now. So quite frankly, I think he was a few decades too early. But, as I kind of see it now, and as early as five years ago I didn’t see this at all, but as of now, I kind of see that– and he always said, this would happen eventually. He didn’t really know when. Unfortunately, it’s going to happen beyond his life, but I can kind of see things coming through the way, almost exactly the way that he would have described it.
CONSUELO MACK: You want to make it quite clear to the world that even though you’re really well-known for your shorts, that Greenlight Capital is, in fact, net long; that you are long more stocks than you are short stocks. And yet, at this particular point, you describe yourself as having a modest net long position. So what, the ratio now is what, one and a half longs to one short versus–
DAVID EINHORN: Yeah, about that.
CONSUELO MACK: – normally it would be two to three longs to one short?
DAVID EINHORN: Yeah, I think that’s about right.
CONSUELO MACK: All right. So why do you have a modest net long position?
DAVID EINHORN: We have a modest net long position because it’s actually relatively easy right now to find things to sell short. And it’s a little bit harder to find things to own. So as we look at the mix of things, there’s a lot of businesses right now, there’s nothing really wrong with the businesses. They’re established companies with long track records, but they’re mediocre businesses. And they’re trading at very fancy multiples. And so it’s very easy to find those things to sell short. It’s a little bit harder right now to find things to buy, although we’ve managed to find some.
CONSUELO MACK: Can we talk about some of the longs?
DAVID EINHORN: Absolutely.
CONSUELO MACK: And again, some of the longs that, as a hedge fund manager, you have to be careful, but some of the ones that we know that are, that it’s public knowledge that you own at Greenlight.
DAVID EINHORN: Absolutely.
CONSUELO MACK: Pfizer.
DAVID EINHORN: Pfizer. Pfizer is a company that has a known problem. The problem is, their biggest drug, Lipitor, is coming off of patent, and so everybody is concerned that there won’t be a lot of growth in the earnings coming beyond the patent cliff. I think this is just a known thing, and we’re going to have to just own Pfizer from here to there, and then we’ll see that there’s still a lot of earnings afterwards. The company has been massively unsuccessful in its research and development over the last decade. And I believe that they’re going to take a much more conservative view towards the R&D spending, which hasn’t been contributing very much value in any case. And so I think that there, and in some other areas, they’re going to be able to sort of cost cut themselves to maintain the profitability that they’re promising people, and then when people see that there’s still more than two dollars a share of earnings, even without patented Lipitor driving the results, I think there’ll be an opportunity for the multiple to improve on those earnings.
CONSUELO MACK: Does dividends have anything to do with this?
DAVID EINHORN: Well, they pay a nice dividend, and that’s fine as well.
CONSUELO MACK: Apple. And you have a history with Apple, but it’s a relatively recent acquisition, again. Right?
DAVID EINHORN: Right. Yes. I looked up in 1999, in December, we bought Apple at $14 a share. And then in January of 2000, we sold it for about $18 a share. And then we– yeah. The IRR on that was fantastic, but it was one of the worst sales that I’ve ever come upon. And from there, it took off, and it seemed to trade at a very high multiple for a long time, and obviously, deservedly so, because of all the great things that they’ve done over the last ten years. Well, in any case, in the recent correction that we had over the summer, the stock came in a bit, and the earnings have really expanded to the point where even a value investor like me could get comfortable with the valuation. And looking at Apple today, the stock is about $310, or $320 a share. There’s about $45 a share in cash. So you’re paying about $265 for the business. I think they’re going to earn well over $20 a share in the next year, so you’re looking at a PE net of the cash in the low teens, which is below a market multiple.
I think that Apple is still in the reasonably early stages of what they can do with their phones, with the iPad, and all of these sales feed demand for people to get Mac notebooks and desktops. And I think that there’s still really quite a long way for the growth of this company, and to get to buy a company with this sort of growth profile, effectively a low teens multiple, of an unlevered balance sheet, I think is a good opportunity.CONSUELO MACK: So what is it that attracts you to look at a company as a buy?
DAVID EINHORN: Well, usually we think we figure out something that isn’t generally understood, or we feel like a company is being put into a group with a lot of other companies, and it’s somehow different from those other companies. And so, if we think we have some sort of a unique insight. But sometimes the insight is rather straight forward.
CONSUELO MACK: As in the case of Apple.
DAVID EINHORN: In the case of Apple, there’s a negative story. The negative story is, everybody already owns Apple, so who else is going to be left to buy it? And that seems to me, once you’ve heard that story about five times, there’s a perfectly good reason to go ahead and buy it, because a year from now, they’ll definitely be talking about something else.
CONSUELO MACK: Is there a company that you’ve acquired recently that I should know about, had I paid particular attention to the SEC, to the 13F, that you think really represents the kind of work that you do in deciding to buy a company?
DAVID EINHORN: Sure. One of the things we bought- actually we probably bought it a year ago- but the price hasn’t changed all that much. And the company is CareFusion, which was a spin off of Cardinal Health.
CONSUELO MACK: And you also own Cardinal Health.
DAVID EINHORN: And we also own Cardinal Health, which is a totally separate story. But the basic gist of CareFusion is that Cardinal Health was a low multiple business. And they were told for years, if you bought higher growth higher margin businesses, your multiple would expand. And so they bought a bunch of pretty good businesses, and they paid some prices for them. And they got to the end of the story, and Cardinal Health was still a low margin business, because they do so much revenues in their distribution, that with the low margin, it was still having a low multiple. So they decided to split the businesses, in part, and they made CareFusion, which is basically an assemblage of the high multiple, high growth, high margin businesses that they had acquired over time. So it’s things like home infusion pumps, and ventilators, and hospital storage systems, and some vaccination type of equipment and so forth. These are actually rather good businesses, and they spun them off. And at the same time, they lowered guidance in both companies and so they sort of set the bar very low.
Now, the infusion business has a neat opportunity because one of their competitors, Baxter, has to recall a lot of their equipment, and CareFusion is going to be able to take a fair amount of market share. And what’s neat is, not only do they get the sales at the infusion pumps, but about a year after that they’ll start getting the recurring revenue from the disposables that come with each thing. And that’s where the high margin or high multiple is. So we think there’s an opportunity here for them to expand their revenues, to expand their margins, obviously expand their earnings, and we don’t believe that this has been fully adopted by Wall Street, which is very focused on medical devices and health care reform, and all the problems that go within that sector.CONSUELO MACK: Let’s talk about the short side. And that’s where you made your reputation, and because you were shorting Lehman early, Allied Capital, you got some short positions now. But what is it that attracts you to a company that makes you think, “That’s an interesting short?”
DAVID EINHORN: I don’t think that there’s anything that different about what we do with shorts versus what we do with longs. We’re basically looking for a market misperception, a misunderstanding about what the company is about, what the company is up to, what the financials say, and what its prospects are. And more often than not, as you mentioned, it’s a long idea. And quite honestly, in terms of what I talked about at conferences and publicly, I’ve presented two or three times more long ideas than short ideas.
CONSUELO MACK: They never get covered
DAVID EINHORN: Well, it’s less interesting, I guess.
CONSUELO MACK: Right. Right.
DAVID EINHORN: As it’s turned out.
CONSUELO MACK: But for those of us who don’t short, and many individuals don’t short, is there something, are there any warning signs of a company that you would short, that basically, for the rest of us would be, avoid this company, because it’s not going to be a good investment?
DAVID EINHORN: I don’t think you can boil it down to particular bullet points. I think there’s behaviors that you can look for that are indicative of a potential problem, particularly once the problem has begun to be raised publicly.
CONSUELO MACK: Such as?
DAVID EINHORN: Such as management not answering questions directly. If there’s a question about a business, or a prospect or something, and sometimes involved in the long-short debate, or in a newspaper article; when somebody gets a newspaper article written about them, and they make a lousy comment about the news publication, it’s usually a sign that there’s some other sort of problem going on.
CONSUELO MACK: Let’s talk about a couple of shorts that you’re involved in now. One of them is Moody’s. Why are you shorting Moody’s?
DAVID EINHORN: We’re short Moody’s, both because we think the business shouldn’t continue to persist in its current form, and as hopeful optimists, we think eventually the world will come to see it that way. But also, and more practically, because of the liabilities that they’ve incurred, as a result of their previous behaviors. You know, the legal system in the United States takes a long time. When you file a suit, there’s motions, and this, and paperwork, and back, and then they do discovery. And there’s a schedule, and people go on vacation, and then you have your trial, and then the judge spends a long time thinking about it, and then there’s appeals. And so the process really takes a very long time.
But the facts of the matter really are that what Moody’s did during the credit crisis, or before the credit crisis, has caused a lot of bond holders to lose a lot of money, and it’s not because they got the housing market wrong. It was because they didn’t do what they said that they were doing. And I believe that ultimately, at the end of the day, one or more of these law suits is going to prove successful. When you think about the number of billions of dollars of bonds that are involved, and the relatively small cash reserves that Moody has, and its ability to borrow, you’re looking at liabilities that could prove to be very large, coming out of effectively the shareholders of the company.CONSUELO MACK: So let me ask you about one last short, and that is the St. Joe Company, which is a real estate developer in Florida. And which happens, also, to be a very large long holding of another WealthTrack guest, Bruce Berkowitz of the Fairholme Fund. What don’t you like about the St. Joe Company?
DAVID EINHORN: The problem with the St. Joe Company is they have a lot of land. And they have a lot of expenses. I think about $50 million a year of overhead. And the problem is, is that the value of the land is not going up faster than the amount of the expenses that they actually have. And it seems like a small problem, because what’s $50 million of expense? But the problem is, the stock trades well above what the value of the land is worth today, and every day the company exists, the expenses are more than the value of the land, so the value of the company actually falls over time.
CONSUELO MACK: All right. How worried are you about the health of the banking sector right now?
DAVID EINHORN: I think there’s a lot of reason to be worried about the health of the banking sector.
CONSUELO MACK: And what should individuals be watching, after all of this, and I mean, what are the kinds of things that, to protect themselves, should they be watching and– I mean, who can they trust?
DAVID EINHORN: Well, the best thing for investors to do is to trust themselves. Nobody cares about your money more than you do. Not your financial advisor, not, you know, whoever is telling you what it is what you should do. And if you’re thinking about, and you feel like you can analyze and invest stocks yourself, this is fine. If you think you think you can analyze and have an advisor that helps you, and you trust the advisor not because they’re a professional, but because you think they give sensible advice, that’s fine. If you want to hire a money manager to help you, that’s also fine. But you should pick and choose and use your own gut instinct, because at the end of the day, whether you succeed or whether you fail, nobody’s going to care more than you.
And frankly, that’s something I translate into my own investing. When we manage the fund at Greenlight, I want to have the portfolio how I want it to be. I don’t want to worry about what I think my investors want, or what other constituencies want. Because my attitude is, if we do badly and we don’t succeed, I want the failure to be because we at least did it doing what we thought was best. Not what somebody else told us that they thought was best, or we thought that they wanted. And that’s how we manage our fund every day.CONSUELO MACK: Music, I’m sure, to your investors’ ears. So David Einhorn, thank you so much for joining us from Greenlight Capital. We really appreciate the time you’ve given us.
DAVID EINHORN: Thank you.
CONSUELO MACK: David Einhorn’s new edition of Fooling Some of the People is now available on Amazon.com. It is a fascinating and thought provoking story.
We also wanted to tell you about an exclusive podcast interview I did with the street’s long time, top rated Washington analyst Tom Gallagher. Tom recently retired from ISI Group but he is as plugged in as ever. Among the topics we discussed, the surprising reaction the Federal Reserve might have to the recent barrage of criticism against it… you can hear it all on our website wealthtrack.com. Thank you so much for visiting with us. Have a happy Thanksgiving. And make the week ahead a profitable and a productive one.
