Greenlight Capital letter to investors Q1 2014 below
April 22, 2014
The Greenlight Capital funds (the “Partnerships”) returned (1.5)%,1 net of fees and expenses, in the first quarter of 2014.
From a profit and loss perspective it was a quiet quarter. Our longs were modestly profitable, our shorts lost a bit more than we made on our longs, and macro lost a little. The net result was a small loss in a market where some indices were up a little and others were down a little.
Micron Technology (MU), our only significant winner, advanced from $21.75 to $23.66 and frankly there isn’t much to say about a 9% gain. Our Keurig Green Mountain (GMCR) short, which jumped from $75.54 to $105.59, was our only significant loser. The company announced a major strategic partnership with Coca Cola. We have lots to say about this, but we’ll defer that discussion to another time and, perhaps, another format.
There was a good amount of activity in the portfolio. We added several new long ideas including large positions in Resona Holdings (Japan: 8308) and SunEdison (SUNE), and medium-sized positions in Altice S.A. (Netherlands: ATC) and Conn’s (CONN). We also shorted a group of high-flying momentum stocks that we have dubbed The Bubble Basket.
We established a position in Resona, the largest Japanese regional bank, at a price of ¥547, representing 0.8x book value and 8x earnings. Resona was formed through the 2002-2003 merger and recapitalization of three local banks in the Tokyo and Osaka regions. As part of that recapitalization, the Japanese government bought a majority equity stake. Under new management, the bank cleaned up its balance sheet, began paying back the government stake, and has been profitable every year since, reaching a 13% ROE last year. In 2013, management announced a five-year plan to buy out the remaining government shareholding. Due to stronger than expected earnings, that plan is well ahead of schedule, and the company is buying back stock from the government at very attractive valuations. The accretion from the buyback does not appear to be reflected in analyst models. With the more volatile international Japanese banks trading at 9x EPS, and its peer regionals at 13x EPS, Resona is cheap on both an absolute and relative basis. Resona shares ended the quarter at ¥499.
SUNE, formerly known as MEMC, is a developer of solar power plants for businesses and utilities. The declining cost of solar energy combined with the rising cost of conventionally produced electricity should position SUNE as a winner. The company has built a large pipeline of attractive projects secured by credit-worthy buyers of electricity. Until recently, the good business was mixed in with two bad ones: manufacturing wafers for semiconductor companies,
1 Source: Greenlight Capital. Please refer to information contained in the disclosures at the end of the letter.
and assembling commodity solar modules for developers. Historically, the company’s poor balance sheet forced it to sell many of its solar development projects at discounted prices to raise capital.
The company has now exited the solar module assembly business and is in the process of monetizing its semiconductor wafer business through an IPO. Later this year, we expect the company will IPO a newly-created Yieldco, which will house its most attractive solar projects rather than selling them to third parties. NRG Yield Inc. is a comparable company that trades at 12x EBITDA and has a 3% dividend yield. Were Yieldco to trade at 9x EBITDA and a 5% dividend yield it would imply a value for the solar business of ~$34 per share. SUNE expects to run its development business close to breakeven in future periods. Adding in the value of the soon-to-be IPO’ed semiconductor business and subtracting a modest amount of corporate net debt would suggest a sum of the parts value for SUNE of ~$35 per share. Our average entry price is $15.55 and SUNE shares ended the quarter at $18.84.
We established a position in ATC at an average price of €28.47. ATC owns integrated telecom assets (principally cable and some mobile) across Europe, Israel and the Caribbean. Its largest asset is a controlling stake in French cable operator Numericable. ATC’s business is very stable and grows organically at a healthy clip. ATC’s management owns a lot of stock and has an excellent track record in both operations and capital allocation. We see substantial upside given management’s ability to improve core margins while making strategic acquisitions and disposals across ATC’s portfolio. Importantly, Numericable has struck a deal to acquire SFR (France’s second largest telecom operator) from Vivendi, which will create significant synergies from consolidating the French market. Presuming most of those synergies, we purchased ATC for less than 6x estimated 2016 EBITDA and a greater than 15% free cash flow yield to the equity. Beyond 2016, we expect ATC to grow EBITDA more than 10% per year for a number of years. ATC shares ended the quarter at €32.34.
CONN is a specialty retailer of appliances, furniture, mattresses and electronics with 79 locations in Texas and the Southwest. CONN finances 77% of customer purchases through its proprietary subprime credit portfolio. In February, the company announced 33% comparable store sales growth in Q4 with strong gross margins. However, it also announced increased credit losses and reduced earnings guidance from a range of $3.80 -$4.00 to a range of $3.40-$3.70 for calendar 2014. Given the market’s past experience with deterioration in subprime credit, the stock reaction was severe: The price fell from $79 at the start of the year to $32 on the news. We believe that this is a retailer with 15-20% unit growth and current double digit comparable store sales growth, and that the market overreacted to moderately bad news. We acquired shares at an average price of $35.49 and they ended the quarter at $38.85.
We have repeatedly noted that it is dangerous to short stocks that have disconnected from traditional valuation methods. After all, twice a silly price is not twice as silly; it’s still just silly. This understanding limited our enthusiasm for shorting the handful of momentum stocks that dominated the headlines last year. Now there is a clear consensus that we are witnessing our second tech bubble in 15 years. What is uncertain is how much further the bubble can expand, and what might pop it.
In our view the current bubble is an echo of the previous tech bubble, but with fewer large capitalization stocks and much less public enthusiasm. Some indications that we are pretty far along include:
The rejection of conventional valuation methods;
Short-sellers forced to cover due to intolerable mark-to-market losses; and
Huge first day IPO pops for companies that have done little more than use the right buzzwords and attract the right venture capital.
And once again, certain “cool kid” companies and the cheerleading analysts are pretending that compensation paid in equity isn’t an expense because it is “non-cash.” Would these companies be able to retain their highly talented workforces if they stopped doling out large amounts of equity? If you are trying to determine the creditworthiness of these ventures, it might make sense to back out non-cash expenses. But if you are an