Below is a copy of Greenlight Capital’s Q4 2014 letter to investors, a copy of which was obtained by ValueWalk. Check back soon for further analysis. The full PDF can be viewed at the very end of the text
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The Greenlight Capital funds (the “Partnerships”) returned 5.6%,1 net of fees and expenses, in the fourth quarter of 2014, bringing the full year net return to 8.0%. Since inception in May 1996, Greenlight Capital, L.P. has returned 2,416% cumulatively or 18.9% annualized, both net of fees and expenses.
The long, short and macro portfolios contributed 3.3%, 4.5% and 0.1% of alpha respectively to the gross annual return of the Partnerships; market beta added an additional 3.7%. Though the S&P 500 returned more than 13% for the year, most other developed markets performed much worse, especially on a dollar basis. While the overall environment was reasonably favorable and we would have both liked and expected to do better, we judge our full year result to be fair.
The recent collapse in oil has become a topic of much debate. Lower oil prices are generally good for the U.S. economy, because for consumers the lower price has the impact of a tax cut; it leaves more money available for other purchases. However, when the price falls so much that it leads to job losses in the energy industry, it leaves the overall impact more ambiguous. While GDP and earnings growth should remain strong through the first quarter of 2015, which has an easy comparison against last year’s bad weather, the bar will be higher later this year.
At last year’s Sohn Investment Conference, Stan Druckenmiller introduced Zachary Schreiber as a rising star. Zach lived up to the praise with a compelling presentation predicting a sharp fall in WTI oil prices, leading us to review our exposure. In mid-June we sold enough WTI oil futures to offset the subsequent declines in our positions in Anadarko, BP, McDermott, and National Oilwell Varco, all of which we effectively exited at their higher June prices.
Greenlight Capital’s significant winners
The fourth quarter was a good quarter for the Partnerships. Longs, shorts and macro were all profitable, and the gains were broad-based. The significant winners were:
- Apple (AAPL): The shares advanced from $100.75 to $110.38. The new phones appear to be selling at record levels. Earnings per share have grown 20% for the last couple quarters and are likely to accelerate in the near term. AAPL shares remain inexpensive at 14x 2015 estimates and less than 12x net of cash.
- U.S. Steel (X) short: The shares fell from $39.17 to $26.74. As we suspected, management engineered a perception of a steel shortage that caused customers to panic and the price to soar. This quarter, that reversed and the position turned profitable for the year. While the sell-side analysts rushed to raise estimates on the way up, they have been much slower to revisit them on the way down. The shares appear superficially cheap compared to 2015 estimated EPS of $3.10, but given the current outlook for steel, we suspect the company will have difficulty showing any profits this year.
- Yen put options: The yen fell from ¥109.64 to ¥119.68 per dollar. The Bank of Japan announced an even more aggressive program of quantitative easing (debt monetization). Japan has government debt that is unlikely to ever be repaid through future tax collections and it is becoming clear that the response is to try to print its way out of the problem. It will be interesting to see if Japan can succeed without significant hardship – other than manageable currency weakness – because Japan may prove to be a portent for other overly indebted sovereigns. As we believe that the best case for Japan is a weak currency, we continue to hold yen put options.
- Industrial Short A: This manufacturer is sensitive to the energy sector. The decline in oil prices helped drive the shares down about 40%.
- Crude oil futures short: As described above, WTI oil fell from about $91 to $53 per barrel.
We had just one significant loser during the quarter. Civeo (CVEO) shares collapsed from $11.61 to $4.11. This was driven by tanking oil prices further reducing expectations for 2015. We did not hedge CVEO’s exposure to oil, because we viewed it as a real estate company and underestimated its sensitivity to commodity prices.
We made several new long investments during the quarter.
Citizens Financial Group (CFG) went public at the end of the third quarter. The Royal Bank of Scotland (RBS) sold 25% of its stake in the IPO and has plans to divest its remaining stake by the end of 2016. While CFG is overcapitalized and currently generates a low ROE relative to peers, it plans to improve its ROE over the next two years through a combination of loan and fee income growth, cost reductions, capital return and a partial normalization of interest rates. We purchased CFG at $22.01, a discount to tangible book value and a significant valuation discount to its banking peers. Over time, we believe the eventual exit of RBS and improvement in CFG’s ROE will drive improvement in the stock’s valuation. CFG management received stock incentives at the time of the IPO, aligning their interests with shareholders. CFG shares ended the quarter at $24.86.
ISS A/S (Denmark: ISS) is a new long position that has been a long time coming. We initially tried to buy the stock in a proposed 2011 IPO that was postponed for three years. ISS is a Danish-based global outsourcer of labor-intensive services, employing over 500,000 people primarily in cleaning, catering, security and property maintenance. ISS is an extremely stable business that grows revenue a few percent nearly every year with modest margin expansion. We view this very high quality business as being comparable to Aramark, which trades at around 20x EPS. We established our position at an average price of 162.73 DKK, which is less than 12x 2015 estimated earnings. ISS finished the year at 178.10 DKK.
We established a position in Keysight Technologies (KEYS), a maker of electronic test and measurement equipment. The business was spun out of Agilent (A) in November2014. We believe Agilent treated KEYS as a cash flow source to fund other businesses.
We expect that as an independent company starting with an almost unlevered balance sheet, KEYS will have the flexibility to invest in unexploited growth initiatives and make better R&D and capital allocation decisions. We believe the Street doesn’t fully appreciate KEYS’ prospects. We purchased our position at an average price of $30.54, or about 12x near-term EPS, which doesn’t yet benefit from the investment spend. The shares ended the quarter at $33.77.
In mid-October, AbbVie withdrew its takeover offer for Shire (SHPG) in response to increased uncertainty and political backlash around controversial “tax inversion” transactions. Merger arbitrage funds rushed to unwind positions, causing SHPG shares to fall to levels below where it traded prior to the bid. This occurred despite improvement in the fundamental and legal outlook for SHPG’s product portfolio and the likely receipt of a large break-up fee from AbbVie for terminating the deal. At the same time, arbitrage spreads on other M&A deals – particularly those structured as tax inversions – widened considerably. We subsequently purchased a small-sized stake in SHPG at an average price of $174.35 and a small-sized stake in the Covidien/Medtronic arbitrage at an average spread of $8.79. After positive quarterly earnings and an investor day, SHPG shares recovered and we exited the position at an average price of $211.65. Medtronic reaffirmed its commitment to buy Covidien and the deal spread narrowed, ending the year at $1.93.
Last, we established a new position in Time Warner (TWX). Since 2009, TWX has refocused its business into a collection of high quality assets including basic cable networks (Turner and CNN), a movie studio (Warner Brothers), and the world’s most valuable premium cable network (HBO). In July, Rupert Murdoch launched an opportunistic take-over bid and the shares soared. The TWX board refused to engage, Murdoch walked away and the stock returned to pre-takeover levels. We purchased a position in TWX at an average price of $72.72, believing that management would have to respond forcefully to fend off another advance. In particular, we believed that TWX had an opportunity to more aggressively monetize HBO and to reduce costs across the entire company. Management subsequently announced that HBO would be offered as a standalone streaming product in the U.S., along with various other initiatives that have led to an increase in earnings estimates and a rally in the shares, which ended the year at $85.42.
In November, Biofuel completed its acquisition of JBGL Capital and changed its name to Green Brick Partners (GRBK). We own 49% of the company. David is the new Chairman of the Board and Harry Brandler will also serve as a director. With this transaction, we figured out how to salvage value from the defunct Biofuel public shell, while also creating an attractive platform to accelerate JBGL’s growth in real estate development, homebuilding, and builder financing. While this is a small position, we are pleased that the shares advanced from $1.12 to $8.20 during the year.
After 14 years, we finally exited our position in Einstein Noah Restaurant Group (BAGL). We initially invested in this entity in 2001 through what we thought would be a passive investment in preferred stock. Unfortunately, the former management failed to execute and by 2003 the company was on the brink of insolvency. In response, we converted our preferred stock into nearly all of the common stock, replaced management and most of the board, back-stopped a high-yield financing and guided the company to a better strategic direction. Ultimately, BAGL’s results improved and our efforts were rewarded. In November, JAB Holdings bought the company for $20.25 per share. Over our holding
period, we made over 5x our money or 18% a year. That’s a lot of dough. This is particularly gratifying as we nearly lost our entire original investment. With BAGL gone, St. Joe (shorted in December 2005) is now our longest standing material investment. In addition to BAGL and the energy names already mentioned, we have several other portfolio exits to report:
We purchased Cigna (CI) at the height of the Obamacare scare in mid-2012 at $45.77. Ultimately, Obamacare didn’t injure the business. Earnings grew, the multiple expanded and we exited at an average of $81.67.
We purchased Osram Licht AG (Germany: OSR) when it was spun out from Siemens in 2013 at €25.25. It had all the spin-off dynamics we like to see and the shares touched €50 just nine months after the spin. Despite overstaying our welcome by a bit, we still had a good result, exiting at an average price of €35.66.
We closed our short in Cliffs Natural Resources (CLF). This was part of our iron ore short thesis. Ultimately, iron ore prices fell as we anticipated they would and CLF stock followed from $29.37, where we shorted it, to $11.28, where we covered it.
Turning to operations, we concluded our capital opening in December. We were well oversubscribed. We thank everyone for supporting us, and welcome our many new partners.
Claire Davis left us at the end of 2014 to pursue other interests and spend more time with her family. We wish her success on her future endeavors. Garrett Jones will be relocating to New York, and we will close our Dallas office.
Our London office manager Kim Thompson and her partner Richard Cutler welcomed their first baby in November, Bertram Ellis McQueen Cutler. The British have a flair for names, but we just call him Bertie.
At quarter-end, the largest disclosed long positions in the Partnerships were Apple, Consol Energy, gold, Marvell Technology, Micron Technology and SunEdison. The Partnerships had an average exposure of 96% long and 66% short.
“When the train of history hits a curve, the intellectuals fall off.” – Karl Marx
Greenlight Capital, Inc.