Jim Chanos on shorting EVHC, notes from the 8th annual CNBC and Institutional Investor run Delivering Alpha Conference. – See more of our coverage here.
Q2 hedge fund letters, conference, scoops etc
I want to talk about two companies but before I do I want to put it in a way that makes a little bit more sense to a lot of people. So just for a moment just imagine that we have Melissa and Guy’s Burger Shack. Melissa and Guy’s Burger Shack is not profitable because Melissa and Guy pull $100,000 between the two of them each year and after that the burger shack breaks even.
I am mister private equity, I’m going to come in and suggest that I’m going to buy the burger shack for $100,000 even though it’s not profitable and in order to make it profitable I’m going to ask Melissa and Guy to take a 50% cut in salary. So they’re going to be working 6 days a week 16 hours for $50,000.
But the burger shack will not really be profitable on $50,000. For that an agreement for five years to take that salary cut I’m going to pay you an additional $500,000. So you’re going to get $600,000 for this unprofitable burger shack. You’re going to get a cut in pay cumulatively of $250,000 over five years but you will have gotten more cash upfront. Now who wouldn’t do that deal right? That’s fantastic. This makes a lot of sense to me I’ve got this money and after five years I know that they’re going to leave the burger shack or I’m going to have to pay them their usual salaries or more.
Wall St is doing these deals. What do I mean? In the mid 90’s a group of companies came forward there were about 9-10 of them that were public called physician practice management companies. Their business model was simply to buy up doctor practices typically affiliated with hospitals, pay a reasonable multiple for the existing business and then sign the docs off for 3,5,7 years for reduced salaries but paying them a lump sum that more than offset their reduced salaries similar to my example with Melissa and Guy’s burger joint.
Doctors flocked to this business model they thought it was great, a lot of them were going to retire anyway so the payment was in the form of a capital gain who wouldn’t do this and lots of them did. Lots of companies followed in in the public markets to do this. Why? Because it was an economy of scale.
The lead company doing this was a company called Ficor. They blew up and the reason they blew up was simple was after 3,5,7 years it became obvious to Wall St investors that the reduced salary upfront payment game which was capitalized by the way was a scam, it was simply capitalising salaries upfront.
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