Transcript of David Einhorn‘s remarks from the Greenlight Capital Re, Ltd. (GLRE) earnings call for the third quarter ended September 30, 2018. Einhorn discusses his long position in Brighthouse Financial Inc (BHF).
Thanks, Simon, and good morning, everyone. The Greenlight Re investment portfolio declined 8.4% in the third quarter. Our longs lost 2%, and our shorts lost 5.7%. During the quarter, the S&P 500 Index returned positive 7.7%. Two short positions were among the largest losers in the quarter. A profitless health care company reported a positive revenue surprise, and the shares advanced despite very low margins on the additional revenue. A technology short also proved costly as the market supported a bullish narrative based on insights that won’t materialize for at least a year.
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Our long position at General Motors declined 14.5% in the quarter. The shares were weak due to general fears about auto industry cyclicality and a marginal reduction in GM’s forecast due to higher steel prices and adverse foreign currency movement. GM is currently rolling out its next-generation pickup trucks, which should continue to deliver high margins and profitability. Last week, GM exceeded third quarter earnings estimates by a wide margin. In October, Honda joined SoftBank by investing in Cruise, valuing it over $14 billion. At that value, GM’s stake at Cruise is worth about $7.50 per GM share, meaning GM’s core auto business trades at 4x current earnings. If we include the $2 billion of future Honda payments to Cruise over the next 12 years, which smell like disguised equity investment, the implied valuation of GM Cruise is roughly $50 billion. Today, all of GM is valued at about $51 billion. Brighthouse Financial was our biggest winner in the quarter. In August, the company announced a $200 million buyback. We’re pleased that the company is commencing a capital return program 2 years earlier than projected, yet the shares continue to trade at about 40% of book value, while comparable insurance companies trade closer to book value.
The Tesla short was our second biggest winner in the quarter. Since settling securities fraud charges with the SEC in September, Tesla recently announced a rare quarterly profits. We believe this will be as good as it gets for the company. While Tesla expects to make 65,000 Model 3s in the fourth quarter, we believe it exhausted most of the demand from customers who can afford the highest priced versions of the Model 3. Tesla is contending with a litany of competitive, regulatory, human resources, vehicle quality and capital structure issues.
We initiated a medium-sized long position in Altice USA, which trades at a discount to its pure-play cable peers despite better free cash flow conversion and a better, new investment opportunity profile. We also purchased shares in BT Group, the incumbent telecom operator in the UK. The company is paying an attractive 6% dividend, and we believe that sentiment will turn incrementally more positive as BT exceeds reduced earnings expectations.
During the quarter, we exited long positions in Micron and Twitter. We exited our long position in Mylan with a small loss as U.S. generics declined more than we’d anticipated. We also covered a couple of industrial shorts with medium-sized losses.
In October, the heavy selling and growth in momentum stocks and the relative outperformance of value stocks resulted in a gain of 1.2% in our investment portfolio despite our net long exposure to a week equity market, that saw the S&P 500 decrease by 6.8%. At month end, the portfolio was approximately 92% long and 67% short.
Our underwriting operations continue to perform in line with expectations despite moderate hurricane activity during the quarter. Our innovations unit announced its first three investments during the quarter in diverse areas, such as digital insurance distribution, a self-insured health market, and blockchain insurance applications. We’re excited how our innovation efforts can provide us new business opportunities over time.
Now I’d like to turn the call over to Tim to discuss financial results.
Q&A Session with David Einhorn
Bob Glasspiegel: David, just some general comments. In October, you mentioned you were encouraged that another portfolio acted in the meltdown. Were there any short of dramatic opportunities or chance to close out in the change in the fourth quarter or pretty much the same overall investment strategy?
David Einhorn: We used the market decline in October to reduce some of our short exposure. Other than that, we mostly left things alone.
Bob Glasspiegel: And same question I asked you two years ago. Does the election matter to any of your holdings and...
David Einhorn: It’s hard to say especially on election day. I guess we’ll know a lot more tomorrow.
Bob Glasspiegel: But you’re not -- you haven’t taken any tactical moves in the anticipation?
David Einhorn: Well, I would say that we -- by reducing our shorts in October, we’re positioned a little bit more net long going into the election than we have been earlier in the year.
Simon Burton: David, would you like to jump in with the Brighthouse question?
David Einhorn: Sure. Brighthouse remains a large investment within the portfolio. The company hedges both interest rate risk and equity market risk. The interest rate hedges lose money when rates go up and make money when rates go down. The company marks through its P&L every quarter the profit and loss on those hedges. They do not change on a mark-to-market basis, the corresponding change in the value of the related insurance liabilities. So in a market where rates go up, one should expect a GAAP operating -- a GAAP loss relating to the interest rate hedges and a reversal when rates go down. Overall, for the company, higher rates are a good thing. And so if you look, for example, third quarter they announced last night, they had a loss on their interest rate hedge, but I think it does put the company in a better position overall going forward. They also hedged their equity risk, which is substantial. They’ve changed in the process of evolving that strategy from a futures-based strategy to an options-based strategy. They now take essentially the first $1 billion of risk to the downside and equity decline. The result of that strategy, compared to their prior strategy -- they were just describing on a conference call they had the last hour, was a substantial improvement over their prior strategy.
Over the next few years, they intend to take an increasing amount of equity risk. This coming year, 2019, they expect to take the first $0.5 billion. And the benefit of taking a little bit more risk means that the options that they buy are a little bit further out of the money, which means they cost less. So the hedging cost should decline over time. All told, we think that the company, when you look out on a normalized basis a couple of years from now, should have minimal cost of their equity hedging program, net of the fees that they charge, the insurance policyholders for that risk. But in the meantime, it remains a bit of a drag on the GAAP recorded results.