Value Investing

Sloppy Decisions At Greenlight Capital & Pershing Square?

Sloppy Decisions At Greenlight Capital & Pershing Square by GlobalSlant

Headline:

Massive Flaws at SUNE [SunEdison] + VRX [Valeant] Were Somehow Missed By Both of These High Profile/Well Resourced Hedge Funds


Much has been written about the very poor Q1 ’16 industry wide hedge fund performance. Hedge funds are clearly under attack primarily because of their fee structures. But it ought to be noted that the performance fees [20%] tied to their high water marks, in many cases, have not been triggered for some time. The management fees, though [in most cases], are still being applied. It seems the legacy hedge fund compensation structure of 2&20 will soon enough be replaced by 2or20. For further insight into this issue I encourage all to read my blog post from 12.08.15

Hedge Funds: Courageous Performance Fee Structures “Rule”…Risk-Less Management Fees “Flounder”

Back to the main point….So why the poor performance? Of course it varies from fund to fund and it is a difficult task to manage a hedge fund…a fact frequently overlooked by the mainstream media. Anyway…of greatest concern to hedge fund investors ought not to be the fees [which definitely gnaw into performance] but, rather, the questionable investment calculus [on many very large portfolio positions] deeply cutting into returns. That they were WRONG is not the issue. That they were MONUMENTALLY WRONG…that is the issue.


Let’s graphically [click to enlarge] examine these specific positions: SUNE = Einhorn / Greenlight Capital + VRX = Ackman/Pershing Square. The two price charts below illustrate the significant disappointments both of these companies delivered to Wall Street after peaking around the same time in July 2015.

Greenlight Capital & Pershing Square

Greenlight Capital & Pershing Square

The price moves “down and to the right” were especially swift and brutal…a classic “penthouse to outhouse” result. And both for good reasons. Currently SUNE = Bankrupt and VRX is in the throes of a complex company overhaul highlighted by CEO Michael Pearson’s “dismissal” and a Board of Directors realignment.


The most obvious, and biggest, risk in money management is the possibility of the permanent loss of capital. It is a legitimate consideration that is rarely contemplated at most hedge funds as, historically, position sizes were somewhat limited [even with the application of margin-ed capital]. Furthermore most hedge fund portfolio managers seldom consider that a stock they elect to buy could actually invert…and sustain a price move to/toward zero.

And this was just the case with Einhorn & Ackman as they both emphatically walked straight into Two Enormous & Stinky Piles of Equity “Dog-Pinch” …that is…SUNE and VRX respectively.

To complicate matters both of these positions were one of each firm’s top holdings…suggesting very high levels of confidence…of course, right as the share prices were peaking. According to the SEC’s 13F filings as of 6.30.15 Greenlight had committed 9.32% [second largest holding] of its portfolio to SUNE while Pershing shoveled 29.95% [largest holding] of its capital into VRX.


The hardened conviction for these companies, by both portfolio managers, was plainly evident to all that cared enough to notice.

Greenlight Capital’s Einhorn on SUNE: From October ’14 Robin Hood Conference

A 37 slide presentation/hypothesis on SunEdison. He claimed it was the highest quality solar company and indicated it could only get better.

In contrast to his post-crash laments…

Greenlight Capital on SUNE 10 Months Later: From August ’15 Portfolio Performance Letter

“The overall market environment has become acutely unfavorable for our investment strategy,” Einhorn said Tuesday in a conference call discussing results at Greenlight Capital Re Ltd., the reinsurer where he is chairman. “While we could have done better in a couple spots, we don’t expect to do well when investors shun value stocks in favor of momentum stocks.” Dude…hate to break it to you but SUNE was anything but a value stock.


Pershing Square’s Ackman on VRX: From May ’15 Sohn Conference:

“We spent a year working with Valeant trying to take over Allergan, and one of the frustrations we had, as we got to see Valeant trading at $110 a share, was that we couldn’t buy the stock,” Ackman said during his closing presentation at the 20th annual Sohn Investment Conference on Monday. “But the moment we could, we bought it. You could say we’re late to the party.” Yes Bill. You were quite tardy.

In contrast to his post-crash laments…

Ackman on VRX 11 Months Later: From April ’16 Congressional Testimony

“The first thing I’ve been doing is trying to make sure this company doesn’t go bankrupt.”


The cold/hard facts regarding the fundamental outlooks at both SUNE and VRX were anything but inspiring for a long while. The short interest had built, receded and rebuilt in these tickers many times over. But as my partner likes to say…”they are shorted a reason…lets figure out why” And in some cases it is an arbitrage/hedge and/or pairs trade. In many instances it can actually be quite difficult to ascertain. However in both of these cases there were widespread and considerable doubts about the sustainability of their business models.

Consider the Following:

SUNE:

Never in its history did it produce a 3 month period of positive EBITDA despite massive revenue growth. This revenue growth was mostly subsidized by the U.S. taxpaying public and then morphed into a creative/clever Wall Street financing machine by securitizing/selling future revenue streams tied to their currently unprofitable solar installations [despite the subsidies]. Naturally there was also a boat load of debt and a boastful CEO. Of course it all fell apart.

VRX:

Wall Street’s “roll-up” strategy of serially acquiring companies, employed by Valeant’s CEO Michael Pearson [an ex-McKinsey consultant] is a well worn path. Pearson successfully waved his magic wand eating up other firms for about 5 1/2 years in the hinterlands of Canada [Laval, Quebec]…wreaking of “hiding out” from more extensive investor scrutiny. Not surprisingly, Biovail [the predecessor company to Valeant] was also a comedy of errors…continually fending off allegations of financial malfeasance.

Anyway, what finally exposed VRX was an egregious/aggressive price gouging scheme. Recently acquired and important drugs [to the patient], but not to the prescription drug market in whole, were sharply increased in price. Eventually U.S. regulators questioned/scrutinized VRX’s pricing tactics. This was the beginning of the end and, like ALL roll-ups, when the currency [in this case equity] collapses…so does the company’s business strategy. For now, unlike SUNE, Valeant has survived. However the legacy of billions in goodwill and long term debt [to repurchase shares] still loom on their balance sheet.


How could Einhorn and Ackman, both armed with well paid analysts/consultants, have missed any of these bright red, and very obvious, flags? And given these plausible concerns did both equities warrant such large portfolio positions?

And then as these red flags became fluorescent red, and the stories began to crack, it seems these two mates simply froze for a while as the proverbial tables “turned” and their investment hypothesis’ were eviscerated. Einhorn eventually bailed [but it took a while] while Ackman is now even more intimately involved at VRX [after boldly, and unsuccessfully, attempting to trade around his core position].

So WHAT GIVES…HOW COULD THIS HAPPEN?
The ONLY real answer, as the title of this post indicates = SLOPPY Stock Selection + SLOPPY Capital Management. As in NOT ACUTE and VERY OBTUSE.

These are two very large and very serious investment mistakes…typically the type of mistakes made by rookie day traders…not seasoned veterans like Einhorn + Ackman. And the quick synopsis’ of both SUNE + VRX [from above]…they were both well aware of each company’s obvious flaws. This is NOT a case of ignorance which makes these errors look even worse.

Investors at both Greenlight Capital + Pershing Square ought to be seriously concerned. These outrageous errors will resonate in the minds of even their cornerstone investors for a long while. Recently substantial investment outflows at both funds confirm this unease. Finally, Greenlight Capital + Ackman will be under tremendous investor scrutiny for some time to come…and deservedly so.

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