David Einhorn/Lehman Brothers: Another NYT Hatchet Job

| About: Lehman Brothers (LEH)
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The New York Times business section has disgraced itself three times in less than three weeks with its coverage of Fairfax Financial (FFH) and the David Einhorn/Lehman Brothers (LEH) dust up. Regarding the latter, I posted this response to guest blogger Prof. Steven Davidoff on the NYT Dealbook blog, and below want to rebut the hatchet job written by Louise Story last week, “Lehman Battles An Insurgent Investor”.

Gretchen Morgenson’s “analysis” of Fairfax was completely wrong, but at least she attempted to examine Fairfax’ exposures, balance sheet, future prospects, etc. In contrast, Story’s article didn’t even attempt to address the important issues: instead, it was tabloid journalism at its worst (with an inane boxing marquee graphic to boot!).

The story here is not David Einhorn vs. Erin Callan or Lehman. It’s whether one of the largest financial institutions in the world (with $786 billion on both sides of its balance sheet as of the end of Q1) – a firm that we now know is de facto backstopped by the U.S. government (and U.S. taxpayers) – is dangerously overlevered and underreserved, with a great deal of toxic waste on its balance sheet, about which it’s deceiving investors and regulators.

Einhorn, a highly respected and successful investor, publicly shared his detailed analysis of Lehman at the Ira Sohn conference last month and then made a transcript of his speech widely available (I’ve posted it here; his comments on Lehman begin on page 4). Many investors obviously think his analysis is correct, so why didn’t Ms. Story’s article explore his arguments, present contrary opinions from the company or elsewhere, and really educate its readers on the substantive issues here?

For example, why didn’t Ms. Story ask Lehman why it didn’t disclose that it had $6.5 billion of exposure to CDOs until it slipped this inconvenient fact into a footnote in its Q1 10-Q, and why it has only reserved a mere $200 million (3.1%) against this $6.5 billion of exposure (25% of which is rated below investment grade and is likely worthless)?

Why didn’t she explore how Lehman could possibly have had $695 million of unrealized gains in its corporate equities in Q1 – a quarter in which every major index in the world was down substantially (the S&P 500 was down 9.5%, etc.), and when in the previous four quarters combined, Lehman had a total of $275 million in unrealized gains?

Why didn’t she try to reconcile the $1.1 billion discrepancy in Level 3 assets between what Lehman said in its Q1 conference call vs. what it reported later in its 10-Q?

Einhorn raised a number of important questions like these, which Lehman is not answering, which is what’s causing many investors to believe that Lehman might be fudging its books – and if it is, what else are they fudging? Why didn’t Ms. Story pursue this? Does she not have the expertise to understand these issues? Or was it laziness? Or the pressures of a deadline? Or a belief that all short sellers are evil?

I saw Dan Rather interview Scott McClellan this week at the 92nd Street Y and, when Rather asked him about the role of the press in the run-up to the Iraq War, McClellan said “they were complicit enablers...they fell down on the job.”

Right then, it struck me: his comment exactly describes regulators and the mainstream business media in recent cases of bubbles (internet, then housing/debt/mortgage) and corporate fraud/malfeasance. Jim Chanos blew the whistle on Enron, but did anyone pay attention? Bill Ackman nailed MBIA and Ambac five years ago, but nobody did anything (they ended up blowing themselves up). All sorts of people warned about the dangerous housing/mortgage bubble, but Greenspan and the Feds not only didn’t do anything to stop it, but actively interfered with states’ efforts to stop widespread obvious abuses and exploitation. Finally, Mr. Einhorn documents in excruciating detail in his new book how he discovered all sorts of damning things about Allied Capital (which we’re short), publicly shared his findings (all of which have proven to be correct to the best of my knowledge), yet all he got for his trouble was endless attacks, not only from the company (that’s to be expected), but the press and, worst of all, regulators, who subpoenaed and harassed him for a long, long time.

Einhorn much be feeling a great deal of déjà vu right now. For having the temerity to publicly share his detailed, insightful and as-yet-unrebutted analysis of Lehman, the media is yet again by and large doing a very poor job reporting this story, making it seem like a he-said-she-said pissing contest rather than an extremely important and serious matter.

I’d like to go through Ms. Story’s article very carefully, pointing out its obvious bias and numerous misleading and/or inaccurate statements:

1) For eight months now, Mr. Einhorn, a rabble-rousing hedge fund manager, has pilloried the venerable Lehman Brothers in an effort to drive down the bank’s stock price, which he is betting against.

Rabble-rousing? Pilloried? To see what a smear this is, consider that Ms. Story could have written the sentence as follows: ”Mr. Einhorn, a well respected and highly successful hedge fund manager who has compounded at more than 25% net over more than ten years, first shared his skeptical analysis of Lehman Brothers, in which he has a short position, last November at an investment conference and did so again two weeks ago at another conference.”

2) Lehman Brothers is not amused.

This sentence implies that Einhorn views this as a game. In fact he’s been completely serious and analytical, and has made no personal attacks or inflammatory statements. It could have been written: “Lehman Brothers is struggling to respond to the issues Mr. Einhorn has raised.”

3) Mr. Einhorn, who runs a $6 billion hedge fund called Greenlight Capital, has been profiting from the Lehman’s growing pain.

How about: “Mr. Einhorn’s short position has been profitable to date, as Lehman’s stock has declined in part due to issues Mr. Einhorn has raised publicly.”

4) Critics say he is needlessly fanning fears about the precarious health of the financial industry at the very moment executives are struggling to stabilize their ailing companies.

Who are these critics? If Ms. Story wanted to include this sentence, then she should have gotten someone on the record. And what does she mean by the word “needlessly”? Does she mean “incorrectly”? If so, she should have been clear exactly what the critics said was incorrect about Einhorn’s analysis. Or was her point that his analysis is correct, but he (and everyone else) should just keep quiet about it? This is nonsensical, of course. If Lehman is, in fact, dangerously overleveraged and inadequately capitalized, then it’s a real public service Einhorn is doing to point out the truth, which appears to be leading Lehman to raise more capital, since the U.S. taxpayer is likely on the hook if Lehman blows up!

5) Many on Wall Street still wonder if hedge funds like Greenlight helped bring down Bear Stearns and spread false rumors about the bank, a possibility the Securities and Exchange Commission is investigating.

This is a despicable smear of Einhorn, as it insinuates (without naming single person of the “many on Wall Street”) that Greenlight was involved with the spreading of false rumors which in turn brought down Bear, and practically calls for an SEC investigation of Greenlight. While I’m sure some jokers spread rumors for profit, Einhorn is exactly the opposite: he stands up publicly, in front of hundreds (if not thousands) of people and the media, and clearly and openly lays out his critique, giving the company every opportunity to rebut his analysis. (The fact that Lehman doesn’t do so speaks volumes.)

6) Mr. Einhorn, fresh from his latest round of television appearances…

Oh please – this makes it seem like Einhorn is a publicity seeking media hound. As someone who appears on television or is quoted in a newspaper almost daily, I know something about this and Einhorn is no publicity seeking media hound – he’s usually the opposite of this. He’s simply doing a lot of media appearances because of his new book, not because of Lehman.

7) Mr. Einhorn said he began betting against Lehman’s stock last July, and he has been right so far. But things have not always gone his way. His long battle against the Allied Capital Corporation prompted the S.E.C. to investigate comments he had made about that company, an episode he discusses in his new book, “Fooling Some of the People All of the Time,” which he is busy promoting. And he was a board member and longtime fan of the New Century Financial Corporation, a big subprime mortgage company that filed for bankruptcy last year.

Ms. Story fails to mention Einhorn’s spectacular long-term track record and instead highlights his single worst investment ever. Is that good journalism?

8) Mr. Einhorn instigated the latest dive in Lehman’s stock price two weeks ago when he encouraged other investors to short the stock at a large conference in New York.

This is flat out wrong. I was there and also read the transcript and Einhorn did not encourage anyone to short Lehman. Instead, like every speaker at the conference (most of whom had long ideas), he simply laid out his analysis and disclosed his position.

9) Ms. Callan, 42, spent an hour on the phone with Mr. Einhorn answering questions before his speech. Afterwards, she found herself rebutting some of his assertions to investors.

This is more biased writing, as it makes it seem like Einhorn didn’t listen to or didn’t care what Callan had to say. This could have been written: “Mr. Einhorn spoke with Ms. Callan for more than an hour before his recent speech, raising the concerns he had and giving her the opportunity to address them. As he noted in his speech, he did not find her answers persuasive – a view apparently shared by many other investors based on the many phone calls Ms. Callan has been receiving.”

10) But hours before his speech two weeks ago, trading volume exploded for Lehman stock puts, which are options to sell the stock and profit if its falls. That day, more than 200,000 put contracts against Lehman were sold, up 49 percent from recent typical Lehman put trading.

Without any further elaboration, Ms. Story’s obvious insinuation is that Greenlight was doing the trading or that Einhorn and/or the organizers of the conference leaked the content of his speech to others in advance. Does Ms. Story have evidence of this? Did she ask Einhorn about this? If not, why? If so, why didn’t she include what I’m sure was a categorical denial? I suspect that one or more investors/traders guessed that Einhorn might raise more troubling issues about Lehman in his speech – this wouldn’t have been very hard, given that this is the stock he spoke about at the Value Investing Congress in November, his well-deserved reputation for persistence, and the many new developments around Lehman.

11) Within Lehman, workers are calling Mr. Einhorn’s strategy “short and distort.”

If Ms. Story was going to write this, why didn’t she also get a quote from any number of people who could have said something like: “Within the hedge fund community, Lehman’s strategy is known as ‘lie, cry and deny’”?

12) “His position on shorting Lehman is only going to get traction and be successful if he can succeed in convincing people to drive down the stock,” said Michael Claes, a managing director at the public relations firm Burson-Marsteller. “That’s best accomplished with media exposure.”

I have three comments on this ridiculous quote:

  1. Why might Burson-Marsteller say this? Could it be because they’re a big PR firm that represents big corporations? Might they someday want to represent Lehman or other big financial firms???;
  2. Was Michael Claes in any way qualified to make this comment? Had he analyzed Lehman’s balance sheet, 10-Q, etc.? Had he even read Einhorn’s speech? I’d bet my last dollar that the answer to these questions is no; and
  3. Claes shows zero understanding of the market. No short seller is capable of driving a large-cap, widely followed stock down to any material degree for any meaningful amount of time by simply giving a speech or appearing on TV with a bear case for the stock. (This is also true, by the way, in the 1,000x more common cases of someone touting a stock on the long side.) I’m sure some can point to a few exceptions, by my experience and observation is that the only way anyone can have a meaningful impact on a stock, regardless of how much publicity they get, is if their analysis is previously unknown to the market and becomes widely believed, which in most cases means it’s correct. That’s why Einhorn’s short thesis on Lehman is probably somewhat responsible for the weakness in the stock – nobody has rebutted the accuracy of a single thing he’s said! That’s also why Doug Kass’s widely publicized short thesis on Berkshire Hathaway might have had a tiny impact on the stock dipping from $135,000 to $123,000 in the first half of last month, but then the stock quickly rebounded – because his thesis was wrong (in our opinion).

13) Mr. Hintz of Sanford Bernstein said in a report on Monday that supporters of Mr. Einhorn’s latest arguments are “piling on” against Ms. Callan.

When many different investors all recommend buying, say, Exxon, does anyone say they’re “piling on”?

14) And Buckingham Research Group said his concerns were “just wrong.”

If Ms. Story was going to quote Buckingham Research’s very strong opinion, why didn’t she quote them saying exactly what is “just wrong”? Again, the silence speaks volumes...

15) “These recent criticisms also seem will-timed to take advantage of the market’s concern around weak second-quarter results that we expect for Lehman,” the Buckingham analysts wrote in a report.

This is nonsense. Einhorn didn’t control the timing of the Ira Sohn conference – and he was publicly critical of Lehman nearly six months beforehand.

16) Lehman, like its counterparts, is racing to use less leverage. The bank had a gross leverage ratio of 31.7:1 at the end of the first quarter, meaning it had borrowed $31.70 for each dollar of equity. Lehman has whittled that ratio down to 25:1 through its more than $100 billion in asset sales, said the person close to the company who was given anonymity because he was discussing a pending financial filing. A small amount of the sales were to two hedge funds set up by former Lehman executives.

That last sentence sure caught my eye – can you say “Raptor”? It could be nothing, but given that Lehman is “racing to use less leverage”, it certainly warrants further investigation – which Ms. Story neglects to do.

17) Mr. Einhorn likes to point out that Lehman’s management has incentives to be positive since compensation is tied to performance. Short sellers, he said, receive undue skepticism, and he said he thought he would be getting far less attention if he were discussing a positive view on a company.

At last, buried deep at the end of the article, is a statement representing Einhorn’s perspective. Sorry, but this is much too little, much too late to salvage a terrible piece of “journalism.”

Disclosure: Funds I manage are short Lehman and I know David Einhorn and know that he is an exceptionally high-grade person and investor.