The David Einhorn Effect and Its Limitations

The David Einhorn Effect and Its Limitations
David Einhorn InsiderMonkey (CC BY-ND 2.0)

David Einhorn, the man who has become a verb with many Wall Street heavyweights calling his short-selling tactics as “Einhorning”, has shot to fame because of his unusually bold bets. When the thin and diligent 44-year old speaks at a conference, shares of the company he merely questions start to plunge within minutes. Bloomberg BusinessWeek‘s latest cover story reflects on David Einhorn’s big battles.

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The David Einhorn Effect and Its Limitations

At last year’s Sohn Investment Research Conference, he questioned the construction company Martin Marietta Materials, Inc. (NYSE:MLM) and its shares skidded 14 percent in 8 minutes. He said the Dicks Sporting Goods Inc (NYSE:DKS) would face troubles, and the retailer’s shares plunged 6 percent in 3 minutes. He didn’t mention Herbalife Ltd (NYSE:HLF), which many expected to be criticized by David Einhorn, and its shares soared.

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The impact of his comments on investors is unbelievable. The Wall Street Journal reviewed 22 stocks after they were publicly mentioned by the 44-year old hedge fund manager. Nine companies on which he made negative comments saw their shares plunging 4.9 percent on an average on the same day. Within one month, the average decline was 13 percent.

However, the Einhorn effect is not equally strong when he makes a bullish comment about a company. David Einhorn is positive about Sprint Nextel Corporation (NYSE:S) and Microsoft Corporation (NASDAQ:MSFT). Shares of Diamond Foods, Inc. (NASDAQ:DMND) surged 5.9 percent after he told investors that his hedge fund Greenlight Capital was no longer betting against the company.

Greenlight Capital has about $8.5 billion of assets under management. Started in 1996, the hedge fund has given shareholders about 20 percent average annual return. In 1997, Greenlight Capital returned an eye-popping 57.9 percent, while the returns in 2011 were 31.4 percent. Though Einhorn is popularly known as a short-seller, he has placed money on stocks going up than down, something very few people have noticed. During his 2012 presentation at the Ira Sohn Conference, he told investors that he has ‘created’ a new kind of preferred stock called Greenlight Opportunistic Use of Preferreds, or GO-UPs.

David Einhorn shot to fame with his short bets against Allied Capital and Lehman Brothers Holdings Inc. (PINK:LEHMQ). In 2002, when he spoke at the Ira Sohn Conference, he told the group that Allied Capital had been improperly inflating the value of its debts. The very next day, Allied Capital shares plunged 20 percent, earning Einhorn a hefty profit.

Allied fought Einhorn, giving the hedge fund manager a tough time. But finally, the SEC found blunders in Allied Capital’s business practices and one of its executives pleaded guilty to fraud. Finally in 2009, it was acquired by Ares Capital Corporation (NASDAQ:ARCC).

David Einhorn started attacking Lehman Brothers in late 2007. He told investors during the 2008 Sohn conference that the company was overleveraged and it had covered up massive liabilities on asset-backed securities. Once again he was right!

Long before Bill Ackman started shorting Herbalife Ltd. (NYSE:HLF), Einhorn shorted the stock, raising questions about its sales network during the nutritional supplement company’s earnings call on May 1, 2012. But he exited the position early and avoided the feud currently going on between Bill Ackman, Carl Icahn and Daniel Loeb.

David Einhorn made tons of money for investors by shorting the stocks. But he could repeat the success with his biggest long: Apple Inc. (NASDAQ:AAPL). Einhorn has invested about 10 percent of his fund’s capital or $877 million in Apple shares. He has been investing in Apple Inc. (NASDAQ:AAPL) since 2010 when the stock was at $248, gaining almost 80 percent based on Apple’s current share price. However, Einhorn predicted that Apple Inc’s market value would touch $1 trillion as the company still has plenty of room to grow.

But the stock has been sliding after it touched the all-time high of $705 in September 2012. He tried to push Apple Inc. (NASDAQ:AAPL) shares up, initially by forcing Tim Cook to issue preferred shares or GO-UPs. When Apple Inc. (NASDAQ:AAPL) chief didn’t consider his idea, Einhorn sued the iPhone maker. He finally withdrew the lawsuit on February 28.

Value investor Warren Buffett advised Tim Cook to ignore David Einhorn. Jack Welch said, “I’d blow him off.” The whole Apple Inc. (NASDAQ:AAPL) dilemma has harmed David Einhorn’s reputation.

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