Greenlight Capital

Greenlight Capital Inc. was founded in 1996 by David Einhorn and former co-President Jeffrey A. Keswin. Mr.Einhorn, the President of the firm, together with his team manages a range of value-oriented alternative investment vehicles including hedge funds and reinsurer Greenlight Capital Re. Greenlight Capital also has a fund of funds a private equity fund Greenlight Masters and Greenlight Private Equity Partners. The New York-based Greenlight Capital has returned 22% per annum since its inception and today has almost ten billion dollars under management.

It is a tribute to Mr. Einhorn’s financial gumption that Greenlight Capital, which started with a shoe string budget and less than a million dollars in assets, today is a notable fund with an AUM shy of ten billion dollars. Mr. Einhorn’s precociousness was evident early on from his college years. While attending Cornell, Mr. Einhorn interned at the SEC’s Office of Economic Analysis and penned a thesis on the cyclical regulation of the airline industry. The thesis won him the highest academic laurels in the Government Department. After graduating with a degree in government and then spending two “miserable” years as an investment banking analyst at Donaldson, Lufkin and Jenrette. Mr. Einhorn found his niche at Siegler, Collery & Co (SC), a mid-sized hedge fund, which he joined in 1993.

It was at SC that Mr.Einhorn was initiated into the financial world through the mentorship of Peter Collery. In a nutshell, Mr. Collery guided him through the arduous and intense process of researching a company and then, taught him how to use the research to make investment decisions. In 1996, Mr.Einhorn — along with an SC colleague — launched Greenlight Capital with half a million dollar from his parents and a “green light” from his wife. Mr. Keswin, Mr. Einhorn’s co-founding SC colleague, left the firm 2002.

At heart Greenlight Capital is a long/short value-oriented fund. The firm’s investment philosophy is quite simple: analyze the economic value of a company and ascertain the alignment of interest between management and investors. Instead of the traditional value investors approach of finding cheap securities and analyzing them to figure out the reason for their cheapness, Mr. Einhorn takes the opposite approach in that he tries to determine why a stock is likely to be mispriced or misvalued in the market. Once an idea is established, then Mr. Einhorn proceeds to analyze the stock to determine whether it is cheap or undervalued. To take the next step to invest, Mr. Einhorn emphasizes that it is de rigueur to: one, understand why the opportunity exists and second, to have a substantial analytical edge over the seller.

Another convention, as far as long-only managers and hedge funds are concerned, that Mr. Einhorn eschews is designing his portfolio in accordance with traditional investment horizons. Long-only managers want their portfolios to perform over a half to a full year, while hedge funds want their portfolios to do well within a shorter time period. Mr. Einhorn believes that in either case the investment horizon is too short as “equities are long, if not indefinite-duration, assets.” With that in mind, Greenlight Capital tries to comprise a portfolio wherein some investments are fast performers and others slower. However, the primary idea is to avoid losses and to retain capital without being limited to a time frame. If Mr.Einhorn is concerned with risk in a position, then the position is either reduced or eliminated. And, unlike at SC, the position is not tried to be vindicated by subjecting it to “evolving hypotheses”, i.e. creating a new justification to hold. An exit is not precipitated just because the market disagrees longer than anticipated, but because, as Mr. Einhorn points out, “our analysis is wrong or we just can’t stand the pain.”

At SC Mr. Einhorn learned the virtues of “pair trades”, SC’s largest investments, in that pair trades hedge a portfolio’s investments by eradicating both market risk and industry risk. However, Greenlight Capital, even though it is much indebted to SC for its research process, does not employ pairs trading to construct a portfolio as Mr. Einhorn believes that the second trade in a pair trade is not a justifiable investment other than as a hedge. Conceding to more industry risk, Mr. Einhorn creates a portfolio with what he believes are worthwhile longs and worthwhile shorts, and, thus, establishing a partial market hedge without having to expend capital on “negative-expected-return propositions.”

Rather than compare its results to long-only indices, like relative-return investors, Greenlight Capital aims to achieve absolute returns, i.e. achieve positive returns irrespective of the environment. The difference lies in that a relative-return investor’s concern is whether an investment opportunity will outperform its benchmark, whereas an absolute-return investor worries whether an investment opportunity’s reward outweighs the risk. Furthermore, expounds Mr. Einhorn, given the disparate perspectives, the analytical structure for each investor is entirely different and comparing the results of one strategy to the other is akin to comparing apples to oranges.

Greenlight Capital utilizes the risk versus reward strategy to achieve superior, risk-adjusted, positive absolute returns. To efficiently reduce risk, Mr. Einhorn runs a concentrated portfolio. He took his cue from Joel Greenblatt who posits that the addition of more stocks in a portfolio that already has six to eight stocks has a negligible effect on decreasing risk. Difficult as it is to find good stocks, when Mr. Einhorn finds them, he makes sure that Greenlight Capital is invested enough in them rather than in further diversification of the portfolio.

The whole gamut of research, analyses and strategies boils down to Mr. Einhorn’s ability to identify undervalued or overvalued companies and taking corresponding long or short positions in them. For Mr. Einhorn it is like solving the puzzle of putting all the tidbits — facts, analysis, numbers, data, etc. — together into a puzzle creating an above average opportunity to solve the puzzle correctly. (Sounds puzzling!). Even though Mr. Einhorn has done well with his longs such as Apple Inc. and General Motors, it is his shorts that have not only put him in the limelight but also are the ones that have been “hit out of the ballpark”. However, Mr. Einhorn and other short sellers have been criticized for employing a “short and distort” strategy. To make Mr. Einhorn’s case worse, it just happens to be that he is also a notoriously staunch and vociferous activist.

Mr. Einhorn’s activist forays have been well documented including his now famous run ins with Allied Capital Corp. and Lehman Brothers, both businesses are defunct. While most manager can move the prices of stock of a short period of time, Mr. Einhorn has the singular dexterity to uncover information not available at the marketplace and present it to the investors so they may start discounting into individual equities. Usually, this information has to do with dubious management and dodgy accounting practices which were the case with both Allied Capital and Lehman Brothers.

It all started in May 2002 with the Speech delivered by Mr. Einhorn at a conference in New York. In the speech Mr. Einhorn outlined that Allied Capital was using dodgy accounting practices to prop up its assets and fooling its shareholders by serving large “dividends” partly based on new capital contributions in a classic pyramid scheme format. Furthermore, given Mr. Einhorn’s extensive knowledge of accounting regulations, he realized that Allied Capital was formed as a Business Development Company and that it was not using fair-value accounting which is stipulated for BDCs. He was basically accusing the forty plus year old business of fraud. Allied Capital’s stock prices tumbled and what followed was a maelstrom of name calling, allegations and the eventual involvement of both the SEC and the Justice Department.

Accusations and allegations, from both sides, flew back and forth so much so that the SEC ended up investigating both the parties involved. Criminal investigations were launched by the Justice Department to clear up allegations of pretexting, of breaking into financial and e-mail accounts, and of downright deep endemic fraud. In the end it was Mr. EInhorn’s well-documented case that came on top and with the collapse of Allied Capital’s balance sheet and stock price, finally put the whole matter as promised all the proceeds from the book and half the gains from shorting Allied Capital will donated to charity. The whole ordeal which lasted some six years is well recounted in Mr. Einhorn’s book, Fooling some of the people all the time.

The imbroglio with Lehman Brothers, in 2007, was not a deja vu for Mr. Einhorn but another j’accuse moment. Some say that even though Lehman Brothers was already in trouble to begin with, its downfall was exacerbated, and precipitated, by Mr. Einhorn’s 2008 presentation at the Value Investing Congress. In his valuation he warned that the investment bank had too little capital for too much risk by acquiring dubious assets, using a huge amount of borrowed money with only a sliver of equity. Greenlight was obviously shorting Lehman Brothers, hence calls of “short and distort” were flying all over the place. However, Mr. Einhorn pointed out how the investment bank was “trying to “squeeze” and intimidate short sellers” rather than trying to get their house in order. So, he went as far as to caution Mr. Cox, Mr. Paulson and Mr. Bernanke about the risk Lehman Brothers was creating in the financial system and that the trio should steer the company recognize its losses and de lever. That advice obviously fell upon deaf ears and we all know Lehman Brothers tragic fate.

Mr. Einhorn does not blame the management only but takes his accusations all the way to the Feds and the government. He believes that the Obama administration is just following in the footpaths of the Bush administration in that its propping up asset prices and reflating the popped credit bubble while hoping for an economic recovery. The Obama administration’s response to bank solvency had been that of two choices: nationalizing the banks or supporting them with tax money. The better solution, according to Mr. Einhorn, would have been to figure out how to induce debt for equity conversions.

Mr. Einhorn’s frustration with the administration and the Fed is well known. His recent “Simpsonian” declamation of the Federal Reserve for its “Jelly Donut” policy towards trying to fix the beleaguered economy proves his point that everyone in Washington is sugarcoating the issues at hand and not trying to resolve them. If the ZIRP (Zero interest rate policy) continues which essentially discourages investors to invest in bonds, the government will over-borrow and basically up in a debt trap: suppressing equity prices and economic growth. And to further defy the Fed, Mr Einhorn is “shorting” the Fed by being bullish on gold, as the endless printing and negative real interest rates keep gold prices in a bull market. And another prominent manager, Kyle Bass of Hayman Funds, agrees saying, “Buying Gold Is Just Buying a Put against the Idiocy of the Political Cycle. It’s That Simple!”.

And as far as regulating the financial sector, the SEC’s and the financial regulators’ slow pace in implementing changes has resulted in companies reaching the end point of no return. Mr. Einhorn also takes on the rating agencies Moody’s, Greenlight Capital has shorted it, and Standard & Poor because he believes that they have failed to measure corporate risk, their putative expertise. The agencies not only failed to warn financial institutions of acquiring risky assets by downgrading their ratings, but for their own short term earnings systematically disguised the financial risk.

Mr. Einhorn, a well-known and accomplished poker player, has a tendency to call everybody’s bluff and has usually come on top. However, this year hasn’t been all roses for Mr. Einhorn: his failed attempt to acquire minority ownership in the Mets and a fine of $11.2 million by U.K. regulators for alleged insider trading in shares of Punch Taverns. Plus, Mr. Einhorn got out bluffed by his opponent at the final table of a three-day World Series of Poker No Limit Hold ‘Em event in Las Vegas. However, he finished at a very respectable third place and has donated his winnings, $4.35 million, to charity. Las Vegas was happy to see him leave without giving any presentations or speeches regarding the gambling industry.

QUOTES

“He’s an outside-the-box thinker. His portfolio doesn’t look remotely like anybody else’s. He does extraordinarily detailed work.” Whitney Tilson T2 Partners

“We start by asking why a security is likely to be misvalued in the market. Once we have a theory, we analyze the security to determine if it is, in fact, cheap or overvalued.”

“Zero-rate policy makes traditional riskless investments, such as CDs and Money Markets, unattractive to savers. Rather than view this as an unfortunate consequence of policy, Chairman Bernanke sees this as a benefit. He subscribes to the philosophy that rising stock prices will contribute to a ‘virtuous cycle’ of economic growth.”
“I think having very low zero rates is depressing to people … I think it deprives savers of reasonable incomes, the ability to forecast a reasonable income, and it cuts down on consumption.”

“What I like is solving the puzzles. I think that what you are dealing with here is incomplete information. You’ve got little bits of things. You have facts. You have analysis. You have numbers. You have people’s motivations. And you try to put this together into a puzzle or decode the puzzle in a way that allows you to have a way better than average opportunity to do well if you solve on the puzzle correctly, and that’s the best part of the business.”