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Greenlight Capital Re (NASDAQ:GLRE) is trading around $22.50 today. The company reported earnings a couples weeks ago, and considering that the S&P was down 14% in the quarter, it was quite impressive that the Greenlight portfolio remained roughly flat. In fact, they posted a gain of 0.1%.

Surprisingly, the stock has underperformed its change in book value. Today, adjusted for their October and November months, I calculate that the stock is actually trading at 1.02x book. This is about as cheap as I have seen it, and especially surprising given his market beating numbers since the summer sell off began.

David Einhorn, who runs the portfolio for Greenlight, is one of the smartest fund managers out there. If you don't want to own GLRE, then looking at how he has positioned his portfolio is quite valuable. Their recently filed 10Q details this, and I have summarized much of it here.

The Next Berkshire Hathaway?

Before I get to the quarterly results and his portfolio construct today, I thought it was important to illustrate exactly why one should follow Einhorn carefully. Simply put, he has a tremendous long term record of beating the market. He is developing a record comparable to Berkshire Hathaway (NYSE:BRK.A)(NYSE:BRK.B), generating market beating returns year in and year out.

However, compared to Warren Buffett, Einhorn is in his early 40s, Greenlight sports a relatively small $850mm market cap, and trades at book value. Compared to Buffett, it seems a no-brainer to own GLRE as Berkshire Hathaway is trading now at 1.1x book, has a $190 BILLION market cap, and is too big really to beat the market by as much as Greenlight can.

To get a long term view of GLRE, I dug into the 10Ks back to 2005, when Greenlight Capital Re was founded. The table below indicates that GLRE has grown book value per share at a compounded annual growth rate of nearly 12% since that time. That compares with a meager 1.9% for the S&P 500.

Put differently, $100 invested in GLRE at book value back in 2005, would today be worth $217, compared a similar investment in the S&P 500 being worth only $117. Clearly the power of compounding is important. I also like that risk management has been solid. That is, in 2008, book value only fell 19% compared to a disastrous down 37% year for the S&P.

2005

2006

2007

2008

2009

2010

2011 AVG

GLRE BV/Share

$11.63

$14.27

$16.57

$13.39

$18.95

$21.39

$22.13e

11.84%

GLRE ROE

14.20%

22.70%

16.12%

(19.19%)

41.52%

12.88%

3.93%

S&P 500 Returns

4.79%

15.74%

5.46%

(37.22%)

27.10%

14.32%

0.00%

1.89%

Excess Return

9.41%

6.96%

10.66%

18.03%

14.42%

-1.44%

2.93%

9.95%

So, Greenlight has beaten the market by an average of almost 10% per year since 2005. Since 2006, Berkshire Hathaway has grown its BV/share by an average of 6% a year. Still better than the S&P by a long shot, but not quite up to the level of Greenlight.

Side note: There is a difference between the firm’s investment returns, and its growth in book value per share. I used the growth in BV/share which is all encompassing. While almost all of the return is driven by Greenlight’s investment portfolio, there is some implied leverage and some impact from the underwriting side of the business. But not much.

Quarterly Results

First off, considering that the S&P fell approximately 14% in Q3, and the portfolio returned a 0.10% positive return in the quarter, is very encouraging. There were some underwriting losses however, totaling about $5.6mm. So net income in the quarter ended up to be around negative $4.5mm, or a loss of $0.12 a share. Book value per diluted share, perhaps the most important metric, fell a smidge to $19.74 at the end of September.

In the table above, I show a book value of $22.23, which is higher than the reported $19.74. I estimated today’s book by doing the following.

(mm's)

Per Share

Market Cap

$853

$22.93

Book @ Sept 30

$766

$19.74

Plus Oct Gains

$69

$1.82

Plus Nov Gains

$9

$0.25

Underwriting Losses

($5)

($0.13)

Book Today

$843

$22.13

Price to Book

1.02

x

The October gains were discussed on the conference call and posted on their website. The investment portfolio was up 6.9% in October, and I even estimated that in November the fund has added a bit more to their gains, mostly by looking at their biggest long positions and their returns. To be conservative, I added in some underwriting losses, as lately a commercial motor liability contract has been losing money. (It’s in runoff but according to the company, it’s likely to take 2 to 2.5 years).

Biggest Stock Positions

November to Date

AAPL

-0.99%

GLD

4.1%

MSFT

-0.2%

VOD

1.1%

GDX

6.5%

PFE

Sold

Top 5

2.1%

Long impact

1.5%

Short

-0.6%

0.9%

As far as stocks, Einhorn’s top five positions have changed a little in the quarter. He sold his stake in Pfizer, reportedly at a gain, and also initiated a couple new positions in autos (NYSE:GM), tech (NASDAQ:MRVL), and in media (NYSE:CBS). He swapped out of some physical gold, and bought GDX and a few mining stocks. GDX is now one of his top 5 positions. Given that gold has outperformed miners by a long shot since 2008, it seems like an easy trade if you have a longer time horizon.

In the June quarter, the firm added tons of Microsoft (NASDAQ:MSFT) and Apple (NASDAQ:AAPL), some Best Buy (NYSE:BBY) and Seagate (NASDAQ:STX). Its seems his Sprint (NYSE:S) trade has been a weak performer, as his foray into Yahoo (NASDAQ:YHOO) lasted a very short time before he bailed. That is actually quite unlike Einhorn to trade so quickly. Part of his talent is in sticking with trades for long periods of time, sometimes years.

Overall Portfolio

Perhaps more important than his individual stock picks however, is Einhorn’s portfolio construct:

12/31/2010

9/30/2011

Commodities

$132

13%

$139

14%

Listed Equities Long

$840

80%

$794

78%

Private Equities

$47

4%

$52

5%

97%

97%

Listed Equities Short

($725)

-69%

($495)

-49%

Debt Instruments

$14

1%

($154)

-15%

-68%

-64%

Net Long Position

29%

33%

Today GLRE is 33% net long, roughly 97% gross long by 64% gross short. I think his shorts are probably concentrated in some of the same names, including St Joes (NYSE:JOE) and Green Mountain Coffee (NASDAQ:GMCR). GMCR fell dramatically after Einhorn pitched the short at a conference a few weeks ago. If you aren’t convinced that Einhorn is one of the smartest investors, then take a look at his GMCR slides here to get a sense for the level of due diligence he does on a position.

As far as his commodity exposure, I assume this is the firm’s physical gold position. Having 10-15% of a portfolio in gold seems smart given the only path to deleveraging worldwide is via debt monetization. That is, the printing of euros, dollars, pounds and yen. For all of the mess that is going on in Europe, ultimately the ECB will likely succumb to the only real means of funding losses: printing euros. Having a macro hedge in gold seems warranted, no matter what your feelings are about a gold bubble.

Greenlight also is heavily short debt instruments, to the tune of 15% of their portfolio. That is a big increase since year end. In the September 10Q, you will find that $153mm of that $154mm of shorts is related to non-US sovereign credit. I fully expect that he is short European sovereigns, but there might some Japanese Government Bond shorts in the mix too. I doubt he has any emerging market bond shorts given the better D/GDP metrics in the EM world.

Credit Default Swaps

What is really interesting about the Einhorn’s sovereign picks, however, is his long credit default swap (CDS) book. Being long CDS is the equivalent of being short bonds, or short the credit. While the mark to market value of CDS can be small, it’s important to look at the notional value of CDS to gauge positioning. From the latest 10Q:

SOVEREIGN CREDIT DEFAULT SWAP POSITIONS

Long protection (Short Credit)

($273)

Short protection (Long Credit)

$44

Net long (short) in Sovereign CDS

($229)

Sovereign outright shorts

($153)

Total

($382)

As percentage of portfolio

(38%)

Having a 38% short position non-US sovereign credit is a huge bet. There is no disclosure on what exactly the sovereign CDS is, but I can only guess that he is long protection of PIIGS debt, perhaps Belgium and France too. A blow up in Europe will no doubt wreak havoc on his long equity positions, but he will have substantial protection from the meltdown that is occurring in euroland. A 20c hit to bonds in Italy for instance, if that is where he is positioned, would equate to a gain of $76mm roughly speaking, or a 7.5% gain on the portfolio. Keep in mind that Italian bonds are trading in the mid 80s today (mid 7% yields), and Greek bonds are in the 40s.

Currency Positions

Finally, Greenlight has a few currency trades on:

Impact on Portfolio

Interest Rate Options

$28

2.77%

100 bps increase

Short Euro

$13

1.31%

10% increase in USD

Short Yen

$18

1.84%

10% increase in USD

If rates in the U.S. go up by 1%, the portfolio will make $28mm, or 2.8%. I can only guess that he is long treasury put options, or perhaps they are simply straightforward interest rate swaps. Either way, it’s a good bet. Can treasury yields possibly go any lower? 2% yields on the 10 year are ridiculously tight and the Fed cannot lower rates anymore either.

Finally, a blowup of the Euro or the Yen would also make some money for Greenlight. Who really wants to own Yen, when Debt to GDP is 200%, and Japan economically has some serious structural headwinds in terms of losing worldwide export market share, not to mention an aging and declining population?

Conclusion

It is very hard to put many of these positions on. I cannot borrow foreign bonds, nor can I buy CDS protection on a basket of European sovereign bonds. Interest rate trades are also tough; the best I can do is buy a name like TBF or simply short the ten year. Owning GLRE indirectly gets me access to lots of good macro and micro positions.

Since the company went public back in May 2007, at 1.4x book, its grown book value from around $15 per share, to today’s level of over $22 per share. But the stock has lagged, only trading from $19 to $22.50 today. The premium multiple on the stock has entirely disappeared. Much of the upside in the stock, apart from its market beating returns, will be from seeing it trade back to a more normalized level of 1.3x to 1.5x book.

To put some numbers around that, assuming book value can grow at meager 5% a year for the next two years, and gets back to a 1.4x multiple, implies the stock can easily get to $34 per share, for a total two year return of over 50%. Not bad for a portfolio that has plenty of smart hedges to protect your downside too.

Disclosure: I am long GLRE.

Source: Greenlight Capital: The Next Berkshire Hathaway?