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Greenlight Capital 2Q17 Letter – Bubble Basket is Frustrating (Amazon, Netflix, Tesla, athenahealth)

Greenlight Capital 2Q17 Letter, July 14, 2017

“Doubt is not a pleasant condition, but certainty is absurd” – Voltaire

  • Returned -4.0%, net of fees, in 2Q17 versus S&P 500 of 3.1%
  • YTD -2.8%, net of fees, versus S&P 500 of 9.3%
  • Long book was marginally profitable but the short book proved more costly; bubble basket was particularly frustrating
  • Amazon (Short Position)
    • Rose 9% after modestly beating March quarter sales and earnings estimates
    • Again guided down next quarter estimates to well below consensus expectations
    • Since last October, consensus 2017 earnings estimates have fallen from $10.75 to $6.73, while shares have risen 16%
      • P/E multiple went from 76x to 145x
    • Amazon announced the purchase of Whole Foods for $14 billion, essentially buying a “brick and mortar” footprint of mostly leased retail space for over $800 per square foot
    • Amazon has said nothing and left the interpretation to the market’s imagination
  • athenahealth (Short Position)
    • Finished the quarter up 25% despite falling almost 20% on the day after it announced 1Q earnings
    • For the first time in history, sharply reduced full year guidance
    • Has long touted itself as a 30% top line grower but revenues grew by 12% in the March quarter and are expected to grow only 11% for the year
    • One-time opportunity to benefit from doctors using government subsidies to adopt electronic recordkeeping has passed
    • Elliott announced a large stake in May: shares immediately repriced
    • Cannot say for certain that no one will buy the company for an inflated price but we disagree that the math works for a going private transaction
      • With a $5.6 Bn market cap, $120M of expected EBITA, no historical free cash flow after capital spending, and rapidly decelerating revenue growth, don’t see how an acquisition works for a buyer
  • Netflix (Short Position)
    • Missed guidance for new customers and increased its forecast for cash burn
    • Key metrics are all deteriorating and customer acquisition costs are higher, yet the stock ended the quarter up 1%
    • Cash investment is now more than 100% of revenues and company is growing its content spend per customer faster than it is growing revenue per customer
    • Despite the availability of nearly free equity, NFLX is funding its cash burn with debt
  • Tesla (Short Position)
    • Finished the quarter up 30%
    • Bulls look at Elon Musk and think of Steve Jobs and decides TSLA is the next APPL
    • Why Tesla is not the next Apple:
      • When Apple launched the iPhone, it was immediately profitable; TSLA does not make money selling cars and Musk shows little interest in profits
      • When one person buys an Apple product, it makes experience for other customers better by supporting the developer ecosystem – this network effect attracts a stable and growing user base; TSLA is unlikely to sustain a competitive advantage by having a network of charging stations or by accumulating driver data
      • Competition was slow to develop for Apple; every major car company intends to compete with TSLA; consortiums are installing competing charging networks
      • Steve Jobs attracted and retained a senior team of loyal lieutenants who implemented his vision; Mr. Musk is a one-man show
    • We do not pair trade and do not view TSLA short as related to GM but have few observations:
      • GM is capitalized to survive any foreseeable downturn – it has $20Bn of cash and $14.5Bn undrawn revolver and is generating billions of dollars in free cash flow; TSLA is capitalized to survive only the next 3 quarters – company burns more than enough cash to compensate
      • GM bears are focused on overhang from leased vehicles returning to the market, making the case that excess vehicles are forcing down used car pricing, which will pressure new car sales and margins; this may be true but TSLA faces the same risk; 2014 was the first year of TSLA’s 3-year leasing program and many of those cars are hitting the resale market at surprisingly low prices; it is a real risk for TSLA that customers may prefer a three-year-old Model S right now to a Model 3; TSLA’s balance sheet reveals that deposits have been returned to many prospective Model 3 customers
  • Caterpillar (Short Position)
    • Advanced 16% after a strong quarter
    • Though Chinese demand has remained strong, the rest of the business is poised to disappoint
    • Despite enthusiasm for infrastructure stocks after election, legislative progress has been minimal and administration’s “infrastructure week” lacked substance
    • Key commodity markets including iron ore and crude have rolled over
  • Continental Resources (Short Position)
    • Declined 29% during the quarter as oil prices fell
  • AerCap Holdings
    • Met quarterly expectations and is on pace to earn almost $6 per share this year
    • Book value per share has grown 17% in LTM and Moody’s upgraded credit rating to investment grade
    • Announced a fresh $300 million buyback (4% of company) in May
    • Yet, the stock languished at $46.43, up only 1% for the quarter
  • Consol Energy
    • Fell 11% despite increasing EBITDA guidance by 7% and raising its production forecast for this year and next year without raising its capital spending plan
    • Immediate-term natural gas prices were stable (this is not an oil company)
    • Committed to sell or separate its coal business by end of the year
    • Believe overall business is worth substantially more than where the stock trades today
  • General Motors
    • Fell 1% after announcing a strong first quarter, with earnings 15% above consensus estimates
    • Auto sentiment remains poor and GM continues to trade with the lowest multiple in the S&P 500
    • Market is underestimating its longer-term competitive position, the impact of share repurchases, and its current earnings power
  • Mylan
    • Beat quarterly estimates and reiterated earnings guidance
    • Sell-side analysts are doubtful and estimates remain pinned to the bottom of range
    • Stock fell less than a percent, trading at just over 7x 2017E earnings
  • Bayer
    • Beat quarterly estimates; shares performed nicely until the final days when one-time inventory issues in Brazil and relative Euro strength put a damper on second quarter expectations (stock ended up 5% up)
  • Macro was a small drag this quarter as nearly every position lost a small amount

New Positions

  • Added Toshiba at an average price of 234.79 per share (yen)
    • Japanese conglomerate with operations including a memory division, nuclear reactor design and plant maintenance subsidiary, and several other smaller industrial and infrastructure businesses
    • In late 2016, announced a significant write-down in its Westinghouse business relating to cost overruns for two nuclear plants it was constructing for US utilities (caused the stock price to collapse)
    • In March, Westinghouse filed for Chapter 11 in the US which should allow it to exit the money-losing contracts and enable Toshiba to extract value from the subsidiary’s profitable businesses, offsetting its liabilities to the utilities
    • In March, Toshiba began a process to sell a majority stake in its memory business to shore up its balance sheet, although a legal dispute has complicated the process
    • Believe investors will refocus on the significant margin and valuation upside of Toshiba; believe the stock is worth closer to 400 (yens) per share

Exited Positions

  • Closed Altice long position for the second time with another nice gain
  • Exited InterActiveCorp long with a gain as our discount to sum-of-the-parts thesis proved out
  • Closed out multi-year Liberty Global long position after recent operating trends weakened; holding began with a position in Virgin Media in 2012 and together this investment generated an attractive profit and IRR
  • Exited successful 3-year investment in Time Warner; company agreed to sell to AT&T for a healthy premium; held off on exiting until the deal spread narrowed which it now has
  • Ended our decade-long shorts of the credit rating agencies: initially they performed in our favor but we incorrectly believed that agencies would ultimately be held to greater accountability for their malfeasance leading up to the 2008 bubble
  • Closed out a profitable short position in Mallinckrodt; suffered sizable losses when the company bought one of our large shorts, Questcor; rolled that position into Mallinckrodt whose shareholders ultimately paid for the unwise acquisition
Image Source: Bloomberg
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