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Greenlight Capital 1Q17 Letter – GM, AAPL, CC, TSLA, RAD, CNDT, PRGO, Gold

Greenlight Capital 1Q17 Letter, April 25, 2017

“A great deal of intelligence can be invested in ignorance when the need for illusion is deep.” – Saul Bellow

Review

  • Returned 1.3% net of fees in 1Q17 vs. S&P 500 of 6.1%
  • Quiet quarter with profitable longs, losses from shorts, and small profit in macro from gold
    • Apple, Chemours, and gold were the biggest winners and Rite Aid, bubble basket shorts, and short positions in Tesla were the biggest losers
  • At quarter-end, largest disclosed long positions in the Partnerships were AerCap, Bayer, CONSOL Energy, GM, and gold; average exposure of 108% long and 80% short

Portfolio

  • Apple: advanced from $115.82 to $143.66 as it reported a good quarter and market is realizing it is not the next Nokia or BlackBerry; durable and its ecosystem is expanding with high-margin recurring services revenue streams
  • Chemours: settled its major litigation relating to the impact of PFOA, discontinued toxic chemical used to make Teflon; bear case arguing that damages would bankrupt the company proved wrong and final figure was within range of expectations; core titanium dioxide business continues to benefit from a tight market and rising prices
  • Gold: nothing significant happened here; gold simply reversed a portion of the post-election decline; remains a long-term position with a thesis that global fiscal and monetary policies remain very risky
  • Rite Aid: expected that Walgreens and RAD would satisfy regulatory concerns and close the merger at $9 per share; instead, deal was re-cut and even at this date, regulatory concerns are not resolved; watching the situation carefully and have trimmed the position as our original thinking was incorrect
  • Difficult quarter to be short the bubble basket, and TSLA in particular: perhaps as the prospects for tax reform have dimmed, the market has regained enthusiasm for profitless companies that aren’t at risk of paying taxes; a number of these stocks are back in full-blown momentum mode
    • The bulls explain that traditional valuation metrics no longer apply to certain stocks
    • The longs are confident that everyone else who holds these stocks understands the dynamic and won’t sell either
    • With holders reluctant to sell, the stocks can only go up – seemingly to infinity and beyond
    • Seen this before and it’s painful for the shorts
    • There was no catalyst that we know of that burst the dot-com bubble in March 2000 and we don’t have a particular catalyst in mind here
    • The top will be the top, and it’s hard to predict when it will happen; in due time, we expect these bubbles to pop
    • Notably, a number of bubble stocks advanced despite missed expectations and/or falling estimates

New Long Positions

  • Conduent: Xerox spun out its business process outsourcing segment at the end of 2016; CDNT provides transaction and back-office processing for a variety of government and commercial clients; CNDT is burdened with underearning contracts it can renegotiate or exit; some business units can evolve to be profit centers and management is in the process of running off other unprofitable business units; despite current revenue headwinds as the business is restructured, management has committed to growing revenue by end of 2018 and beyond
    • Purchased at an average entry price of $14.76/share, representing 11x conservative case estimate for 2019 earnings
  • Perrigo: Largest manufacturer of private label OTC pharmaceutical products for US retailers and pharmacy chains; in November 2015, shareholders rejected a hostile takeover offer from Mylan worth $175/share after the then-CEO laid out ambitious standalone earnings targets; these targets were too optimistic and CEO ultimately departed; believe new management has now set achievable earnings forecasts; company has a dominant market position in its core US OTC business and should continue to grow profits in this segment; believe US OTC business and Omega have profit and growth characteristics similar to consumer products businesses which trade at healthy multiples due to stability of their cash flows
    • Purchased PRGO at an average price of $68.81/share or 11x our estimate of 19 earnings
  • European financial institution: cannot discuss at this time as per our policy regarding the new European market regulations

GM

  • Prefer to avoid public activism and the last time we did this was with Apple in 2013 after owning the stock for 3 years
    • Similar situation; had owned GM for years before advancing our idea to management
  • When we offer companies private advice and they reject the idea, we understand the reasoning and prefer not to press the issue; sometimes, we agree to disagree, and then decide whether to hold or exit the position
  • In the case of GM, felt the need to press the issue as we believe there is a lot of value to unlock and the company did not fairly evaluate our idea
    • Management made a decision and spent a great deal of effort to justify that decision
    • To poison our idea, went so far as to misrepresent the proposal to the credit agencies
    • Ironically, our idea was designed to be credit positive and the least invasive way to unlock billions of dollars of shareholder value
    • This sort of behavior leaves us no room to agree to disagree
  • We know this is a tough fight but the math is on our side and the ultimate decision will be made by fellow shareholders
    • Believe others recognize that stock is deeply undervalued and when shareholders grasp the math and the extent of GM’s behavior, they will vote with their wallets and for needed change at the Board level
  • Further Reading: David Einhorn Pushes GM to Split Stock in Two Classes: Plan to Unlock $38 Billion of Value

Exited Positions

  • Closed 3 Canadian bank shorts at a loss as the oil and gas credit loss thesis did not sufficiently materialize
  • Closed LyondellBasell Industries short at a loss: thesis was that large capacity additions, along with a potentially limited supply of raw materials, would squeeze margins; however, new industry capacity has taken longer than expected to come on line
  • Closed RPC, Inc short at a small loss as favorable industry pricing tailwinds have offset our company-specific concerns
  • Closed Signet Jewelers short at a gain when negative comparable store sales and class-action litigation caused the stock to fall

David Einhorn is the founder of Greenlight Capital, a long/short hedge fund with an estimated AUM of over $10 billion as of 2015.

Image Source: Reuters
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