DAVID EINHORN: The Vision To Find That Perfect Short

David Einhorn

[credit provider=”Screenshot from CNBC”]

There are very few people who can tank stocks with PowerPoint presentations. Greenlight Capital’s David Einhorn happens to be one of them.On October 13, 2010, Einhorn spoke at the Value Investor’s conference in New York. There, he presented a 100 slide-plus presentation on a tiny Florida real estate developer few people had heard of: St. Joe Company. While the crowd gasped and laughed along with his presentation, they also contacted the outside world. During the presentation, shares of St. Joe collapsed. The company’s stock price fell nearly 20% by the end of the trading day on October 14.

It takes some time to develop the sort of legacy that gets investors to call their brokers at the sight of a stock ticker. Einhorn started his fund, Greenlight Capital, in 1996 with what now appears a small amount of money under management, $1 million. Over time, the fund grew, as Einhorn developed successful investment theses on stocks like CompuCredit and Conseco. Those were financial firms which Einhorn successfully shorted, profiting from their demise.

The short that really made Einhorn famous was that of Allied Financial. In 2002 at the Ira Sohn Investment Conference, Einhorn revealed in a now infamous speech why he was short Allied (you can watch the full speech here). It starts with a quote about Napoleon, a defence of shorts, and outline of his past successes, a bit like a general trying to amp up his troops before battle. It then delves into Allied Capital.

His attack was scathing. It detailed how Allied’s mezzanine debt positions in particular companies were not properly priced, and how the company was not fully revealing details about companies it owned, like Business Loan Express. After his speech, the company’s stock fell 20% the next day.

But unlike previous shorts, this time Allied fought back. Its CEO stood up to Einhorn, and the SEC began to investigate Einhorn and other hedge fund managers who were shorting firms. Nothing came of those investigations, but the SEC did begin to investigate Allied.

The company was accused of identity theft by Einhorn and others. The company eventually admitted to the charges of pretexting, a form of personal information theft. It eventually settled with the SEC on unrelated charges in 2007. Its stock collapsed in 2009.

Even after his exposure to public scrutiny over his short of Allied, Einhorn remained on the hunt. He, along with his team at Greenlight, built up a basket of financial firms associated with subprime mortgages, the securities at the centre of the financial crisis. These became his subprime shorts, a group he whittled down to six, including Lehman Brothers.

Einhorn publicly revealed his Lehman short at a time when the market was still reeling from the collapse of Bear Sterns. And he grilled the company’s green CFO, Erin Callan. She stumbled on several of his sharper questions about valuations, further evidence for his position. Lehman’s collapse is well known, but Einhorn, like he did with Allied and other firms before, had the vision to see the faults where others simply listened to corporate rhetoric.

Now, Einhorn is involved in yet another very public fight over a short. This one is with another big investor, Bruce Berkowitz, who is long St. Joe. Einhorn believes the firm’s real estate holdings are being overvalued, and is short the company. Berkowitz believes in the future value of the company’s assets, and his fund Fairholme is heavily invested in the company. He released a counter presentation to Einhorn’s.

You may be tempted to side with Einhorn, but his fund has underperformed lately. He’s made short-term mistakes with long calls on Yahoo and Best Buy. Shares of St. Joe have also bounced back from their post-presentation lows.

But it’s not about the short-term wins with big shorts, as Einhorn’s investment in Allied showed. Sometimes it’s about being able to see the next big thing looming, ready to take down a stock or markets once more.

And while short-sellers like himself may come under frequent attack, Einhorn has passionately defended their role in the market, writing on the promotional site for his book:

There is a growing populist sentiment against the hedge fund industry and short-sellers. I agree that it is unfair and elitist for only wealthy people and institutions to have access to some of the best money managers. I also agree that the hedge fund industry has its share of bad players, as do all professions. However, short-sellers need encouragement. They are an important voice in the market. There is a collective benefit we all enjoy by having profit-motivated investors try to sort out the good companies from the bad. Most short-sellers remain anonymous, and after seeing what I have gone through for simply calling a spade a spade, who could blame them? The only people discussing short-sellers are the even more motivated management teams who get caught with their hand in the cookie jar. They scream loudly, point fingers and make wild accusations, and many uncritical listeners buy into the distraction.

Whether or not you agree with the technique, Einhorn has shown great vision exploiting firms denying realities or fraudulently representing their accounts, making him, and his clients, tremendous amounts of money in the process.