David Einhorn Comments on the Credit Market and His Portfolio

Last Friday I (along with 359 of my closest friends) had breakfast with David Einhorn, the founder and CEO of Greenlight Capital, a value-oriented hedge fund. With annualized returns averaging over 27% since inception in 1996, Greenlight Capital is well-known and well-respected in the hedge fund community as is its founder.

I think Mr. Einhorn views himself as a value investor, but not necessarily a "traditional" one. He was quoted in the past saying, "We take the traditional value investor's process and just flip it around a little bit. The traditional value investor asks 'Is this cheap?' and then 'Why is it cheap?' We start by identifying a reason something might be mispriced, and then if we find a reason why something is likely mispriced, then we make a determination whether it's cheap."

Mr. Einhorn was the guest speaker for the 17th annual Graham and Dodge Value Investor's Breakfast hosted by the Columbia Business School (my alma mater). I suspect that most of the attendees there were hoping Mr. Einhorn would open up the tent flap a bit and show off some of stocks he currently owns.

Instead, he presented a very compelling case arguing that the credit ratings industry needs serious restructuring. He asserted that because the ratings agencies are paid by the issuers, they have every incentive to rate credits in such a way to encourage more business for themselves. His solution to this problem, which feels was a major contributor to the credit crisis of last August (the other being structured finance), is to have the users of the credit rating agencies pay for the services rendered.

He also suggested that a lot of assets which were not and could not in August remain on balance sheets among the big banks and elsewhere not marked to market. The crisis may not be fully over in his view.

He also thinks that the rating agencies' prospects would worsen if his plan was adopted. He noted that Moody's Corp. (MCO) has an operating margin of 54%, making it the fourth most profitable company in the S&P 500. This is too high for a company who is supposed to be providing a service to investors trying to assess the risk profile of their investments.

His body language seemed to suggest that Moody's is probably a "sell" in his opinion.

In the Q&A session, Mr. Einhorn did dish a bit and told us about some of his holdings. He likes financial stocks which are not exposed to credit risk such as Ameriprise Financial (AMP) and the UK's Standard Life. In the energy area, he discussed Helix Energy Solutions Group (HLX), which in his view has "boggled" things for quite a while, but will likely get its act together and could show remarkable results in 2008 and/or 2009.

He spent a good deal of time going over the rationale for his investment in the homebuilder MDC Holdings (MDC). At the time he bought the stock he thought the market was mostly discounting the troubles in the housing market (sounds familiar?) and given that MDC had less land holdings than other homebuilders, no off-balance sheet items, and a generally lower-risk profile than most of its peers, he felt it could perform much better than the average homebuilder. He called the stock's performance "a very bad outcome."

During the course of the give and take in the Q&A session, I could sense Mr. Einhorn's deep passion for investing. Many times during the morning he noted the great uncertainty we all deal with in this business. Someone asked him how his investment philosophy has evolved over the years and he answered that the basic philosophy has not changed to a measurable degree. He continues to focus on preservation of capital (his mother was his first client!) and he tries to buy stocks that will "hold up." The scale of effort has gotten much bigger with the growth in assets under management and the many years of doing this has brought with it a measure of addition experience.

Then, as he further reflected on how he approaches the process of finding and buying (or shorting) stocks, he said that despite of all the research and thought, sometimes "... you never really know." Well said.

For me too that is the "buzz" of this biz -- taking those few steps into the darkness not really knowing if your analysis is leading you to the land of Canaan or to the edge of the abyss. Either way, for me, the journey is well worth the effort.

Comments

[kurt walter:]

Einhorn has been trying fo ryears to talk down in public the stocks he is short.

2007 Oct 24 11:11 AM

[Fabry 1973:]

Mike, I'am writing from Italy... I tried to be an expect in securitization and I devoted my professional life to this... despite this, I agree to half of the statements written by david about securitization... it's really a bad practice, but not by itself... it's a bad practice in a highly leveraged world... and we are in this situation now (due to the hard lending, SIV, CDO etc etc etc).
I think that, as many simple finance books indicate, a reasonable amount of leverage is efficient and needed, so, sorry david, but the capital markets has to deleverage for sure, but there is a level where also securitization is useful. and, on rating agencies, I hope for a creaction of a super board of experts (super partes) that will be able to fine rating agencies for bad practice... but lobbies are too strong.... I would check among rating agencies shareholders first...
so, have a good day
ciao
Fabrizio
[e-mail]...

2007 Oct 29 01:29 PM

[Fabry 1973:]

Mike, I'am writing from Italy... I tried to be an expect in securitization and I devoted my professional life to this... despite this, I agree to half of the statements written by david about securitization... it's really a bad practice, but not by itself... it's a bad practice in a highly leveraged world... and we are in this situation now (due to the hard lending, SIV, CDO etc etc etc).
I think that, as many simple finance books indicate, a reasonable amount of leverage is efficient and needed, so, sorry david, but the capital markets has to deleverage for sure, but there is a level where also securitization is useful. and, on rating agencies, I hope for a creaction of a super board of experts (super partes) that will be able to fine rating agencies for bad practice... but lobbies are too strong.... I would check among rating agencies shareholders first...
so, have a good day
ciao
Fabrizio
[e-mail]...

2007 Oct 29 01:29 PM

[Fabry 1973:]

Mike, I'am writing from Italy... I tried to be an expect in securitization and I devoted my professional life to this... despite this, I agree to half of the statements written by david about securitization... it's really a bad practice, but not by itself... it's a bad practice in a highly leveraged world... and we are in this situation now (due to the hard lending, SIV, CDO etc etc etc).
I think that, as many simple finance books indicate, a reasonable amount of leverage is efficient and needed, so, sorry david, but the capital markets has to deleverage for sure, but there is a level where also securitization is useful. and, on rating agencies, I hope for a creaction of a super board of experts (super partes) that will be able to fine rating agencies for bad practice... but lobbies are too strong.... I would check among rating agencies shareholders first...
so, have a good day
ciao
Fabrizio
[e-mail]...

2007 Oct 29 01:29 PM