This post is about David Einhorn’s Greenlight Capital, Greenlight RE (“GLRE”), one of his (reportedly) largest portfolio investments, and related book about another famous investor that I am rereading.
First, what prompted this post, largely, was that I heard some of the media types mocking David Einhorn on Bloomberg Surveillance, earlier this week after Einhorn’s most recent quarterly letter dropped. I posted before about Einhorn and one of the ways retail investors can get exposure to him: Greenlight Reinsurance (“GLRE”).
Shorting Stocks
Einhorn was (reportedly) down about 14% in his funds during the first quarter. See Bloomberg. It seems like his longs were down more than his shorts. As I said in my prior post, I really do not like shorting. Stocks go up over time, even if only as a result of inflation, shorting is expensive, and your downside is theoretically infinite, while your upside is capped at 100%.
It just seems like its usually a negative expected return bet. I don’t think that over the long term the additional utility from having something going up when everything else is going down is worth the cost (also….Treasuries or Bunds). Even some of the most “successful” short hedge funds are only able to stay in business because they sell their funds as insurance (which, fittingly, is also usually a negative expected return proposition). See Thinking Fast and Slow.
Even that fierce woman running the short fund in the Valeant episode of “Dirty Money” on Netflix, which you should watch by the way, is probably a negative expected return bet (although, she might be worth it).
After seeing this Netflix documentary, I think a Valeant long might be a scarlet letter to rule out a money manager for the rest of your investing career. We had all that scuzzy price gouging, the tax gaming to move the HQ to Canada, Charlie Munger calling it a cesspool, and you are still aggressively long? Yikes!
Einhorn also has gold as a large position (top three, I think). I agree with Buffett about gold. It’s basically a shiny metal you can fondle and generates no return other than some archaic, psychic benefit. I would much rather own some strip shopping centers.
For these reasons, I am not long GLRE, despite my natural inclination to buy stock in a smart manager when media types are brazenly mocking him. GLRE is trading at around 70% of book value as of the last earnings report. Of course, this book value doesn’t reflect these interim losses. The losses also, however, represent additional gains that will have to be earned without a performance fee until the high water mark is reached. I will continue to track GLRE. If it gets around a 50% discount, I will probably have to start a position…fees, shorting, and gold position be damned.
Brighthouse Financial
Speaking of companies trading at a 50% discount to book value, Brighthouse Financial (“BHF”) is one of Einhorn’s largest positions and it is trading in that vicinity. BHF is a recent spin-off or MetLife’s retail business. They sell/provide annuities and life insurance direct to consumers (as opposed to providing a workplace plans, which bidness MetLife retained). Snoopy was apparently a casualty of the divorce.
BHF seems cheap based on financial metrics. It is trading at below 50% price to book, and below 1.0 times trailing 12 months revenue. I found some estimates for 2018 earnings that place it at around a 6x price-to-earnings ratio, but I don’t think there is enough history to get confident in that (also insurance companies can basically report whatever they want in earnings over the short term). Here’s a link to the investor relations section containing quarterly results. I like their results section, by the way. They include transcripts of their quarterly calls. I think all companies should do this.
We should probably always ask ourselves, “Why is it cheap?” The first thing I would note, and you will see in the most recent quarterly results, is that BHF just had to take like $38 million charge to increase reserves (anticipated payouts) related to a legacy MetLife business, that it is n longer in charge of, but for which it apparently retains part of the risk. Basically this business was insuring/taking over pensions and MetLife decided it was writing off potential beneficiaries too aggressively when they lost contact (for example, assuming they were dead and wouldn’t draw in the future).
Obviously, something like this doesn’t give a lot of confidence in what else MetLife put on the books. It also highlights one reason many probably sell spin-offs as a reflex. They did not invest in this company or these managers and the new company is beholden to the old company for many things, especially in the beginning. BHF points to service contracts with Met rolling off as a key area for cost savings, but until then I guess Met is running the show on those expenses.
A couple of other reasons why BHF is likely cheap are: 1) It is a spin-off; and 2) it sells annuities and life insurance; and 3) the DOL fiduciary rule.
Spin-off are often reflexively sold for some valid reasons and some not so valid reasons. They are a good hunting-ground and Mr. Greenblatt and many others have documented. BHF is a good example. It’s a lot smaller than the company you bought if you bought MetLife. It has no track record, management is different, and the financials are all messy. Sell Sell Sell!
Annuities and life insurance are sort of disliked as a business right now. For one reason, the Department of Labor has been working on a standard that might make it difficult to sell, at least the annuities, to clients. Do some google-fu if you’re interested, but I think the fear is that, in the future, anything other than a low cost index fund might get financial advisors sued. That has been rolled back for now, under the Trump administration. I personally think the business is likely to continue to exist (albeit perhaps with lower fees).
I know people who just can’t handle the quotation volatility and would be better served buying an annuity that “smooths” their returns in exchange for 200 – 300 basis points skimmed “off the top” of the investment returns.
Another reason why the industry is kind of disliked right now is that annuity and life insurers invest a lot of their premiums in fixed income securities. They hold these to meet future obligations. The low interest rate, low inflation, environment has not been good for them, especially if they assumed higher interest rates when setting premiums and benefits in writing policies, before the Great Financial Crisis.
Finally, as Buffett has said, the insurance industry is not one where there are real barriers to entry. Capital can come flooding in the moment the rates firm up and profits start getting fat (often, after a bunch of capital has been destroyed). So, you know, there are some valid reasons why it might be cheap.
Lincoln National Corp is probably a decent comp for BHF and it also trades at just over 1.0 times price-to-sales, at a discount to tangible book, and at a sub 10x P/E ratio. So it is also seemingly, cheap. Although, not as cheap as BHF. It also is not a brand new company with new management, beholden somewhat to the acts of its prior parent.
I also wanted to note that this period kind of reminds me a little of the period when Shelby Davis, Sr. started building his fortune, after the Great Depression, by focusing on cheap insurance stocks. I am re-reading a book about the Davis family currently: The Davis Dynasty: 50 Years of Successful Investing on Wall Street.
After the Great Depression, rates were similarly low and weighing on life insurer returns, but Davis (at least according to the author) predicted future growth and that low rates and inflation would not persist forever.
Then again, maybe he just decided to “buy it cheap and something good might happen.” At that time, insurers were also struggling due to low equity returns. That reversed course in their favor as well (pushing Davis’ fortune along). Equities seem to have strongly rebounded after the GFC, so I wouldn’t argue that we’re in a totally identical environment.
The catalyst for BHF to become less cheap might be beginning capital returns. As of right now they are not paying a dividend or buying back stock. BHF is planning to build regulatory capital of $3 billion excess over an industry metric for capital sufficiency. As of last quarter, they were up to $2.6 billion. Einhorn thinks they will reach this level faster than management has projected. Buying back stock at a 50% discount to book could really compound some value for remaining shareholders.
In conclusion: 1) BHF is cheap; 2) Einhorn is a really smart investor (especially in financials); 3) industry may be currently penalized by recency/hindsight bias and potential for mean reversion is present; 3) BHF is a spin-off that could close gap with other as forced selling abates; and 4) returns of capital could provide a relatively quick catalyst.
P.S.
After publishing this post I came across this post on the FT’s Alphaville blog, David Einhorn, in search of lost time. I suppose the FT’s post really sort of sets forth the view which prompted my post in the first place. It is, however, a thought provoking piece that posits the hypothesis that Einhorn is suffering from availability bias in recalling his experience in the late 90’s tech bubble, which he is incorrectly expressing in his “bubble basket.”
That certainly could be the case. It is a concern that behavioral errors will impact any manager, especially when we are dealing with someone who is not a systematic quantitative manager.
It could equally be the case, however, that he is applying the same financial rigor in his analysis of these companies, particularly as concerns profitability and cash flow, as he did during the tech bubble. Via this analysis, he may have recognized a valid pattern which has repeated time and again through out the history of human experience. See, e.g. Extraordinary Popular Delusions and The Madness of Crowds.
I find it difficult to objectively marshal arguments that Netflix and Tesla are not expending large amounts of cash, derived from capital injections made by debt and equity investors, in return for uncertain future profits. Or that GM, Ford, and even “old-economy” media stocks like Disney and Liberty Global do not trade at much lower valuations.
The post goes on to consider an interesting counter-factual that Einhorn may not have even survived 1999 to go on to post large outperformance during the “tech wreck” if he had not reaped large gains from a spin-off which exploded with internet hype during that year.
This is an interesting fact, but does not impact my evaluation of Einhorn’s investing prowess. If his investors redeemed their money due to underperformance during the bubble, that would be due to their behavioral errors and performance chasing, not Einhorn’s. It seems he would have posted the same record in either case,although perhaps not with outside money, or perhaps not with as much fanfare. If anything, the fact that he outperformed during 1999 would lead me more to question his process. Although, getting lucky with a cheap spin-off is “right down Broadway” for a good value investor.
Finally, I note that the Alphaville post features a picture of Einhorn at a poker event. This is an interesting reminder that Einhorn has stepped out of the investment management business and won over $5 million dollars in the World Series of Poker. To the best of my knowledge, no other money manager has even approached this feat (although Icahn, Munger, Buffett and of course, Ed Thorp are known to be superb at probability based games of “chance”).
In sum, I encourage you to read the Alphaville piece as it is thought provoking and a good critical take. I still have no position, but I think my bet is that Einhorn will be among the many who are “restored that now are fallen.”