David Einhorn urges Delaware Chancery Court to rule against Elon Musk’s purchase of Twitter. Greenlight Capital commentary for the second quarter ended June 30, 2022.
Read the full letter here.
Dear Partner:
Greenlight Capital’s Performance
The Greenlight Capital funds (the “Partnerships”) returned 8.4%1 in the second quarter of 2022 and 13.2% for the first half of 2022, compared to a 16.1% decline and a 20.0% decline for the S&P 500 index for the quarter and half year, respectively.
Q2 2022 hedge fund letters, conferences and more
The quarterly outperformance vs. the S&P 500 was the best relative performance in the history of the Partnerships. We believe the recent outperformance came from the same discipline that contributed to the prior period of underperformance.
Does this mean that value investing is back? We think the answer is still a resounding no.
To be clear, the environment has been most favorable for us since early last year, after the tail end of the parabolic move in bubble stocks culminated in the meme stock craziness. Still, it isn’t as if investors are now embracing value investing and pouring into value stocks. The community of disciplined value investors has shrunk considerably. Traditional long-only active managers have lost assets to index funds and have generally scaled back their research efforts. Short sellers are significantly diminished and many have left the industry. The market is still dominated by the types of investors who we described in our year-end 2020 letter: those that either will not (index funds), cannot (untrained novice investors) or choose to not (valuation indifferent professional investors) have valuation as a cornerstone of their investment processes. A lot of these investors have had a tough go of it during the current bear market.
We believe that part of the reason value stocks have fared better lately is because value investors have suffered a full redemption cycle and there is hardly anyone left to sell. Another factor may be that some value stocks have become so cheap relative to the earnings of the underlying businesses, companies are able to buy back a large portion of their own market capitalizations. We aren’t relying on other active investors to buy the stocks that we own, so we instead are choosing to emphasize investing in companies that appreciate this dynamic and are creating value both through their operations and through buying back their own stock at very low prices.
Q2 2022 hedge fund letters, conferences and more
Top Five Holdings
Let’s review our five largest holdings as of June 30th in this context:
Atlas Air Worldwide (NASDAQ:AAWW). The shares ended the quarter at $61.71. This is about 65% of book value and less than 4x consensus earnings. The company has bought back 4% of the stock this year and has authorized another 6% buyback.
Brighthouse Financial (NASDAQ:BHF). The shares ended the quarter at $41.02. This is about 25% of book value and less than 3x consensus earnings.2 We expect the company to repurchase 10- 20% of its shares this year.
CONSOL Energy (NYSE:CEIX). The shares ended the quarter at $49.38. Though it trades at a nosebleed 2.6x book value, we expect the company to generate approximately $50 per share in after-tax free cash flow by the end of 2023. Capital returns have not yet begun, but we expect they will shortly.
Green Brick Partners (NYSE:GRBK). The shares ended the quarter at $19.57. This is about 1.1x book value and less than 4x consensus earnings. The company bought back 5% of its shares as of its last quarterly announcement and authorized another buyback of an additional 10% of the shares.
Finally, Teck Resources (NYSE:TECK). The shares ended the quarter at $30.57. This is about 85% of book value and less than 4x consensus earnings. The company recently began buying back its shares. When the CEO was asked on the April 27th quarterly call what the plans were for playing his “really strong hand of cards here,” he responded with, “I’d like to buy the whole company back myself.”
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A Softening Period Of The Economic Cycle
We appear to be entering a softening period of the economic cycle, where it is likely that earnings will fall. So, these stocks may not be as cheap as the P/E multiples suggest. However, we have done our own sensitivity analysis and we think that it is doubtful that any of these companies will see earnings fall by more than 50%. While investors may not be excited about 3-5x “peak” earnings, might they get excited about 6-10x “trough” earnings? Actually, it isn’t so much about investors, who seem absent as described above, but more likely the companies themselves that will create long-term value above and beyond business earnings by repurchasing a chunk of themselves cheaply.
Over the short term, having few others practicing value investing probably does not help us. Over the intermediate term, we believe this setup could generate potentially exciting performance. For example, it might get very interesting if CEIX returns its entire current market capitalization to shareholders in the next 2 or 3 years.
We continue to believe that we are in a bear market. The large declines in the major indexes in the first half of the year make that an obvious statement at this point. However, the tone of the bear market shifted in the second half of June. For a number of months, our portfolio, which is positioned to benefit from inflation, did just that. In mid-June the bear market broadened and inflation beneficiaries fell sharply.
To that end, the Fed raised interest rates by 0.75% and promised to do more. It also began shrinking its balance sheet to tighten monetary conditions. As we expected, the inflation has begun to create an economic slowdown as consumers have to spend more on necessities, leaving less available for discretionary purchases.
Q2 2022 hedge fund letters, conferences and more
Position In Twitter
In April, Musk agreed to buy Twitter Inc (NYSE:TWTR) for $54.20 per share. Then, in May, he appeared to change his mind. The case law on this is quite clear. If it were anyone other than Musk, we would handicap the odds of the buyer wiggling out of the deal to be much less than 5%, or the percentage of bots that might be on Twitter.
But, it is Musk and therefore many believe that the laws again won’t apply. One former judge on the Delaware Chancery Court (where the case is being heard) went on CNBC to speculate that the court might let him out of the deal because Musk won’t respect the judgment, which would embarrass the court. Another variation is the court might rule against him, but TWTR might not be able to enforce the judgment.
Apparently, many people either believe these outcomes are acceptable or, in the alternative, are just the way the world works. We hope it isn’t so.
Actually, we can do more than hope. We purchased a position in TWTR at an average of $37.24 per share. At this price there is $17 per share of upside if TWTR prevails in court and we believe about $17 per share of downside, if the deal breaks. So, we are getting 50-50 odds on something that should happen 95%+ of the time.
We think that the incentive of the Delaware Chancery Court, the preeminent and most respected business court in the nation, is to actually follow the law and apply it here. If it lets Musk off the hook, it will invite many future buyer’s remorse suits. Cynical buyers might contract with targets and then use the threat of litigation and the resulting uncertainty to recut the deal. The Delaware Chancery Court has spent years developing case law relating to merger agreements. The resulting precedent and clear understanding of buyers’ contractual obligations has created a great deal of predictability in this sphere. It will be up to Chancellor McCormick to follow that precedent and protect the sanctity of the court. We like the risk-reward that she will.
Read the full letter here.
