WHEN: Today, Thursday, September 19th
Following is the unofficial transcript of a CNBC EXCLUSIVE interview with James S. Chanos, Kynikos Associates LP Founder and Managing Partner, and Leon Cooperman, Omega Advisors, Inc. Chairman and Chief Executive Officer, live from the CNBC Institutional Investor Delivering Alpha Conference in New York City on Thursday, September 19th.
Short-seller James S. Chanos on why he's shorting food delivery company Grubhub
Leon Cooperman: Interest rates are not the economy's issue
TYLER MATHISEN: Now, as we talked earlier indexing has surpassed active management among publicly traded mutual funds and ETFs, but today we're going to hear from two individuals and one of the highlights of the day, two individuals with long histories on the long and the short side of the markets will give us their best, most urgent investing ideas for now. They've been here before they have been very, very successful in the past, please welcome James Chanos, Founder and Managing Partner of Kynikos Associates and Leon Cooperman, Chairman and CEO of Omega Advisors, and please welcome back, Scott Wapner.
SCOTT WAPNER: Nice see you again, gentlemen. We'll get to your ideas, your best short and your best long ideas in just a minute but I feel like we should get your takes on what's happening in the markets. Lee, I'll ask you first. It's been such an interesting market for us to cover, you've had turbulence and now you've moved back towards new highs, you had a Fed decision yesterday, another rate cut. How do you see the markets? Are we in a good place or not ?
LEON COOPERMAN: My basic theme has been unchanged for a couple years. All of us in this room should recognize we're in a very abnormal world. Okay, and it is my job to figure out what is normal. The reason I say it's abnormal -- there's just no economic justification for $17 trillion of sovereign debt with negative interest rates. You live in a home in Denmark, you get a check every month for living in the home. It's crazy, makes no sense. Okay.
And so, I spend my time trying to figure out what normal is and normal to me is labor force growth, half of 1% a year, productivity in the labor force growing one and a half percent a year -- that defines real growth. That's 2%. And another 2% for inflation, that's 4% nominal. Ultimately in a 4% nominal world, the Fed funds rate ought to be 3% not 2%.
The 10-year government ought to be four, not one eight. It may take two years because of global interest rates to get there. In that world, I objectively or subjectively using the 17-multiple as fair for the S&P, and we're now past Labor Day. We turned the calendar, we’re looking at 2020. We have a 175 estimate in the S&P. If I take 17 times 175 that’s 2975, core 3000. The S&P’s 3005, we’re in a zone of fair value. Market cycles don't end at fair value, they end at overvaluation.
So I would say to me, maybe the market for the next 12 months to say 3300, 2700, currently 3000, fairly valued and I don't understand. I think the President's doing a lot of damage with all this assault of the Fed. You know, I wrote down yesterday when the Fed cut rates. I said consumer confidence is up, retail sales are strong, employment is strong, consumer net worth is at record levels. The economy is growing at trend – we're growing at trend. Corporate profits are decent. Stock repurchase activity which suggests to me corporate managements are not pessimistic.
Okay, rates are already very low. You know, pity the poor saver when somebody comes to retire. What is this financial planner tell that person he’s going to earn or she's going to earn on her savings? You know, people can't afford to retire which has great implications to younger people in terms of their upward mobility in the economy. And then I would say lastly the deficit is going up, not going down. We have a fully employed economy. So, I don't, I vote with the guys in the Fed that didn't want to cut rates.
WAPNER: You think it was a mistake.
COOPERMAN: Mistake, it’s an insurance policy – they rationalize it anyway they want. I think that as much as I feel the markets are in the zone of fair valuation now, I am concerned looking out a year from now and I'm concerned about four things. Number one, nobody seems to be concerned about the debt levels when building up an economy. And, you know, I was personally very surprised how abruptly the economy slowed in the fourth quarter last year in the face of a very nominal increase in interest rates. It tells me too much debt, and there's nobody focusing on that. They want more debt. Secondly, there is unquestionably a shift to the left in this country. They won't open the stock market if Elizabeth Warren is the next president.
Okay, you know, and I'm not a, you know, I take to quoting Winston Churchill: I'm committed to capitalism with all its flaws. Winston Churchill says you don't make poor people rich by making rich people poor. He also said the main vice of capitalism is the uneven distribution of prosperity. The main vice of socialism is the equal distribution of misery.
Okay, the Democratic Party seems to be leaning towards leftist policies which I think are very harmful for economy. So I don't like to shift to the left. I think we're basically margins are above normal, they tend to be mean reverting. So I would say looking at I'm concerned next year, particularly about the election.
WAPNER: Okay. So Jim I was gonna ask you for your market thought first. But given where Lee just went with the political side, I think it's sort of well-known where your support, at least at the current time, is on the political spectrum. Do you take issue with what Lee said?
JAMES S. CHANOS: No, I'm going two hundred percent long and moving to Denmark so they can pay me to live in a house. I'm a short seller. Look, you know we were running always hedge so we don't really have market views. There are times better opportunities in different sectors or different locales, and that's always the case. I will say, what I will say politically though, is that I don't think the stock market is discounting a win by the left in 2020.
You look at things like the for-profit education stocks, for-profit prison stocks, which basically can be impacted by executive order, both positively and negatively. The for-profits were impacted negatively in the Obama administration certainly. Those stocks until very recently were all hitting new highs.
They've only very recently begun to roll over and the company I'm going to mention today would be affected by that as well. So the stock market is pretty confident that – the way I look at it – Lee’s scenario of the stock market not opening after a Warren victory is not going to happen.
WAPNER: You want to respond to that?
COOPERMAN: I’m concerned about that –
WAPNER: He basically says you're wrong.
CHANOS: No, no, no, I'm saying that the stock market doesn't think it's a possibility.
COOPERMAN: I agree with that. The stock market is not focusing on the election.
CHANOS: We agree.
COOPERMAN: The stock market is not focusing on the debt build-up.
WAPNER: Well, the stock market is going to focus on the election as you get closer to 2020.
COOPERMAN: And if it looks like she's a credible alternative, I think the stock market will run into some problems.
WAPNER: What about Biden?
COOPERMAN: Biden's okay – he's centrist – but I don't know that he's acceptable to the progressives. I don't know who's gonna get the nomination.
WAPNER: Okay, so let's do what we came here to do. And let's focus on ideas. Let's try and make some money. Lee Cooperman, you’re up first. Your first best idea – I know you have three stocks that you want to talk about.
COOPERMAN: Yeah I don't like, have a best idea. I find as much as I think the S&P is adequately valued, I’m finding a lot of companies that are very attractively priced. So the way I look at, I first start out with trying to have a view in the market. My market view is neutral plus – the cycle’s not over – the market, the big risk is, I think, is more upside risk than downside risk, but I believe 10 years into a bull market, if you’re finding cheap stocks, there’s something wrong with the stock. This market’s been picked over. So look, the S&P earns 16% in equity.
It grows about 5 or 6% a year, it yields 1.9% of sales, three and a half times book value, debt to capital 40%, 13 times enterprise value, EBITA. And I say I'm looking for things that have more attractive attributes and a low valuation so one that would not do well with a Democratic victory is Cigna. Cigna will generate next year $8 billion of free cash flow. It’s buying back 3 or 4% of the company annually and sells a seven half times estimated earnings.
With a decent balance sheet, they'll be down to 40% debt to capital, after buying Express Scripts, and it seems very cheap at less than half a market multiple growing more than the market. If you take the membership growth, price growth, cap shrink, that’ll probably produce earnings per share growth of 12 to 14%, seven a half times earnings. That's one that I like. Another one, it had a little bit of pop with the Saudi situation, but basically WPX Energy, well-managed – I think this Rick Muncrief has done an excellent job managing the affairs of the company.
We think private market value so in the 18 to 20 are,a I think there'll be consolidation in the industry, they just announced a buyback of 10% of the equity, and they’re just now entering a free cash flow mode. So I think they'll be a constant buyer of their own stock. It sells at around 11 and a half and half of NAV, a little bit more than half of NAV.
WAPNER: You could say more about that stock, I just want you to hold off on the third one. We’ll leave that as a cliff-hanger.
COOPERMAN: The third one is very controversial.
WAPNER: Yes, that’s why I want to leave that out there for a minute. Before we get to that, do you have more you want to say on WPX?
COOPERMAN: $5 billion equity value, 420 million shares, like the CEO, free cash flow growing at 15%, and selling it a mid-single digit multiple, and it sells. I'm very big on the notion that most publicly traded companies, not all but most, have two values. The so-called auction market value, which is the price you and I pay for one share, 1000 shares. And so-called private market value. That price is strategic, a financial investor would pay for the entire business. So I like to find companies that are selling in the public market big discounts to private market value, where I think things can happen.
WAPNER: You mentioned earlier too, how difficult it is, you said the stock market's been so picked over. I assume that you don't think that that's going to reverse itself anytime soon. It's harder to find bottoms up great value companies now.
COOPERMAN: Well, it's harder because we've been in a long cycle, but certainly not possible. I have five guys working with me and gals, and they have nothing but long ideas. They have no trouble finding value. I don't think, look, I've said it on your program often – maybe I’ll even say it at 12 o'clock – you know, bull markets are born of pessimism, they grow in skepticism, they mature in optimism, and they die in euphoria.
Other than the IPO market there's not much euphoria in the market. Euphoria, you know, there is adequately price stocks but not a lot of euphoria and we're coming up with plenty of ideas that we’re willing to buy.
And I think the public is not embracing the stock market. This morning's panel Mary Erdoes made the comment that she thought that people are under invested – I don't know that they're under-invested – but clearly they're not over-invested and, with the exception of the IPO market, which, you know, there is this crazy bubble there. I think the equity market is okay. And what worries me, one of the things that worries me greatly as an investor, and you would think I shouldn't be worried because I’m a professional, right, is the destruction of the market structure.
You know, in the fourth quarter last year, you had almost a record decline in the market with no causative factors at work, other than hedge fund liquidation, tax law selling, and the loss of liquidity in the market, but you know when I joined the industry 51 years ago, basically, the Volcker Rule didn't exist, and the firm's traded stocks for 50 cents a share. Today they trade stocks for next to nothing.
Fidelity has an index fund, no fee, because they get the short rebate. Okay, so the brokerage industry is no longer a source of stability in terms of buying inventory for their account. Number two. When I joined the industry 80% of the volume was in New York Stock Exchange. 80% of the volume today is off the board so the specialist don't perform any function of stabilization.
And lastly, for some unexplained reason and you could ask Jay Clayton this morning – I missed it I was in traffic – but in 1938, the SEC implemented the uptick rule, which worked effectively for 70 odd years, and in 2007 they eliminated the uptick rule, which gave rise to a lot of these quantitative trading systems, which buy strength, sell weakness, and they exaggerate upside and downside, and you know, everyone I know with money, myself included, has generally made money by buying weakness and selling strength, not buying strength and selling weakness.
WAPNER: I know that Jim, you have thoughts about that topic too but I want to tee you up for a news-making idea that you have for us today. Lee gave us some long ideas, and your sort of best short of the moment to share with us is?
CHANOS: Well, I want to talk about. So we've made some money, talking about rent-seeking healthcare companies, where both the financial markets, and the health care market have discovered that a company has basically been overearning for some structural or questionable, legal or regulatory reason we gave *unintelligible* crowd a few years ago at a competitor's conference, spoke about Valeant, which I Charlie Munger famously called a sewer five, six years ago, and one that we have been short for the last couple years that suddenly has a whole spate of new developments that are really troubling is the largest kidney dialysis company DaVita.
CHANOS: Symbol DVA.
WAPNER: You said you've been short for the last couple of years, you're revealing for the first time today the actual name that goes with the story.
CHANOS: Right, because there's been three important developments. First and foremost the federal government is getting more interested in these rent-seeking models, and specifically, President Trump has begun a kidney initiative, which is to push more kidney transplants and more home dialysis, which would not be good for DaVita but would be good for the end-stage renal disease patients that DaVita treats, but more ominously, it's always interesting in my world, when one of your biggest customers sues you for fraud. And this spring, Blue Cross of Florida sued DaVita for a scheme. And if we could put the slide up.
WAPNER: We're going to put it up as you as you're speaking. It was sort of the principal slide that you wanted to refer to and have the audience look at as you made your case.
CHANOS: To basically walk you through – and I would urge anybody interested in the idea to get a copy of that suit – it walks you through this payment scheme that they accuse DaVita up of implementing. DaVita itself has disclosed this a couple years ago in its own slides but no longer puts this slide up. And what Florida has accused and what we believe they're doing, is DaVita is pushing Medicare and Medicaid patients.
Most dialysis patients are old and less affluent and qualify for Medicare and Medicaid in the vast majority of cases. What DaVita is trying to do is to push those patients into, ironically, more expensive commercial insurance contracts through the Obamacare exchanges.
Now, most of these people can't even afford the premiums for Obamacare, but the kidney dialysis providers generally promised them better services, shorter wait time, nicer facilities, so on and so forth. What they do and what's alleged and this has been going on now for a while, is that the kidney dialysis giants, DaVita and Fresenius, tell their customers, look, we'll treat you better if you can be a commercial pay customer. The American Kidney Fund, which is a charity, will pay some, most or all of your premium depending on circumstances, and then you can get these much better services.
They then turn around, using the VSO numbers and charge the commercial payers, three to four x, what they get for Medicare and Medicaid. Now, this is bad enough, but what really is interesting is that the two largest donors, at slightly less than 90% of the donations to the American Kidney Fund, are DaVita and Fresenius. And so they are donating to the charity, the charity is paying the premium into the Obamacare exchange, and they’re then charging the insurers three to four x.
WAPNER: There's the issue, you know, I'm thinking about well, what happens if the courts blow up Obamacare? There's the other thing that you slyly alluded to in your commentary about Munger and Valeant is that Berkshire Hathaway is the largest individual shareholder of DaVita–
CHANOS: By a lot.
WAPNER: --by more than 25%. And one of their co-portfolio managers there, Ted Weschler, has a personal position at least as last that we read, does as well.
CHANOS: Well, I'll get to that in a second but there's an important little addendum to what I just told you and that is the safe harbor, that these dialysis companies – the government's known about this for a while – have operated under is that they don't direct the actual specific charitable giving from the American Kidney Fund to do this scheme, and therefore they have nothing to do with it, they just donate out of the goodness of their heart and shockingly they get this extra reimbursement.
There was a whistle-blower suit that was unsealed this summer, in which an employee for the American Kidney Fund came forward and said, that's not the case, that in fact the kidney dialysis companies direct their charitable giving. And that would blow their safe harbor out of the out of the water if that turns out to be true. A couple other things.
Number one, the government has focused on this now. Representative Katie Porter from California is now looking into this whole issue, because it's inflating premiums in the exchanges, right. The head of Blue Cross California a few years ago famously said, kidney dialysis is destroying some of the exchanges singlehandedly, these excessive payments. That's number one. But the lawsuit, the whistle-blower suit, is amazingly important.
You mentioned Buffett. This company hasn't grown earnings per share in 10 years, despite massive buybacks. It is a company that has done, really bumped along at Lee Cooperman sort of 4% top-line growth for a long, long time with declining margins offset by buybacks. It is trading at almost 40% premium to Fresenius, enterprise value to EBITA.
The reason for that is that that Berkshire Hathaway, as you mentioned, owns over 25%, whatever you might think, this I think is a very bad look for an insurance company like Berkshire Hathaway, to be promoting a company that I think is certainly running an insurance scam, and if the whistle-blower is correct, it's actually insurance fraud. And I just can't understand why Berkshire Hathaway would be promoting a company that's gaming the insurance business is as much as the DaVita is.
WAPNER: Theoretically they would be aware, and understanding of some of the issues that you would—
CHANOS: You would think so.
WAPNER: –be raising though and they've, you know, given their sort of blue ribbon stamp of approval if they have a position that big.
CHANOS: Yeah, well, you would have to ask them, I can't answer for Berkshire Hathaway certainly, but this is a company that's paid a billion two in fines to the government, over the last 10 years as a course of doing business. It's a company that has pages and pages and pages of risk factors in they're 10-K. This is, again, a company that that over 100% of their operating earnings are coming from this scheme. And look, if we get Medicare-for-all, or Medicare option or the ACA is shut down due to the federal court ruling, this business model blows up completely, completely, companies leveraged. So, you have a problem – there's one, and yet there's more.
In 2017, there was a landmark study, published by a fellow by named Kimmel – you can Google Kimmel kidney dialysis and opioid use – dialysis patients are seeing increased amounts of chronic over-opioid use. The reason why this is important, they're not supposed to be taking opioids at all if you look at the medical literature because of the nature, you're cleaning the blood. And in many cases those that are getting chronic opioid use are being prescribed by more than one doctor.
The reason why this is concerning is not only do Fresenius and DiVita see these patients, but DaVita has an actual doctor employee at every center, the medical director who has to be seeing their charts and has to be seeing this opioid use
WAPNER: Are you worried about the liability?
CHANOS: I'm worried the plaintiff’s bar is going to figure out that here's another set of corporate, you know, deep pockets to go after the dialysis guys because of the rampant use of opioids amongst dialysis patients. And because they're being actually overseen by doctors, nephrologists who should know better.
WAPNER: So let's do this. We have about two and a half minutes left. We'll continue our conversation on the Halftime Report in just a little bit, live. Lee. Let's just leave your last idea, let's do it on TV. Let's do it on TV and we'll see—
COOPERMAN: Whatever works for you work for me.
WAPNER: I'm assuming there's a question or two from the audience as we can sort of wrap things up here, does anybody have a question for Mr. Chanos or Mr. Cooperman? If not, we'll just do Lee’s final idea in the two minutes or so we have left. You mentioned businesses that are quite known to people and this is one that don’t talk about that often.
COOPERMAN: It’s known, you know, I like to quote Buffett, despite the commentary before but you know Warren once observed that, basically, the comment was that he likes – I’m losing it for just a second. Well, he said a lot of interesting things but he basically said when a management with a reputation for brilliance tackles a business with a reputation for poor fundamentals, it’s usually the reputation of the business that remain intact. Having said that, this is a one-off, it’s a small position for me, though I own a big percentage of the company, a company called New Media.
If you look at, New Media just announced a proposed merger with Gannett. Okay, if you look at the S-4, which itself is 400 pages long, and dig into it, the pro-forma of this company is 4 billion of revenues, $4 of earnings per share, a probable dividend of $4 in 2022. It would probably have a 35% dividend pay-out ratio it should be about a buck 40 dividend. Okay, they have a present dividend of 76 cents stock, is eight and a half dollars. So you're buying in at, like, two times earnings, three years out, you're getting paid 9% while you wait. The chairman of the board just bought a quarter of a million shares, and slightly higher than the last sale. The two directors bought stock. Okay.
The deal is gonna be voted on mid-November, and I just think it has a very asymmetric reward risk, and something that is just nobody believes in because the newspaper business is a shrinking business, but of their 4 billion in revenues, a billion is digital, which is growing, and the CEO who runs the company is a good guy, knows what he's doing. And like I just said, he just bought a quarter million shares in the open market himself.
WAPNER: So let's do this, let's continue our conversations on live television on the Halftime Report. The Vice President is literally waiting in the wings. So we'll exit stage right and ask all of you to sit tight and enjoy the next conversation. Lee Cooperman, James S. Chanos, thank you very much.