David Einhorn’s 2Q18 Letter: Brighthouse Financial, GM, and Short Tesla & Athenahealth

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  • Another difficult quarter and lost an additional 5.4%, bringing year-to-date loss to 18.3%
  • Environment for value investing has been tough. AllianceBernstein recently reported that value investing strategies are performing in the bottom one percentile since 1990
    • In the past 18 months, Russell 1000 Pure Growth index has outperformed the Russell 1000 Pure Value index by 54%

Brighthouse Financial (BHF)

  • Spin-off from MetLife; had all the spin-off dynamics we like to see
  • The roadshow presentation was practically morbid and almost designed to discourage investing. The most off-putting was management’s plan to refrain from capital returns for three full years to allow the company to “season”
  • Original spin-off document said that book value would be about $93 per share and management guided to a long-term ROE of 9%, implying $8.40 per share of earnings power
  • We paid $57.92 per share or 62% of book value and less than 7x future earnings
  • As often happens in spin-offs, there were last-minute balance sheet adjustments and true-ups which benefitted the new company. Original book value turned out to be $105 per share. Management re-guided the ROE to 8% on the higher denominator, again implying roughly $8.40 per share in earnings
  • BHF reported mediocre, but not terrible, year-end results, driven by slightly higher than expected mortality loss and slightly higher expenses. At the same time, company continued to build excess capital and hinted that capital return could commence sooner than expected
  • BHF steadily fell to $50 by early May, when the company announced first quarter results, which were terrific
    • BHF exceeded expectations across the board and raised its long-term ROE expectation to exceed 8% in 2019 and 2020. Further, the company said capital return could begin sooner than 2020 under certain circumstances
  • BHF stock reacted by jumping 5% at the open. From there, stock traded steadily lower, finished the quarter at $40.07, and it has been our biggest loser so far in 2018
  • We have seen bearish analyses that include concerns about long-term care blocks of business like Genworth (BHF is not in that business) or that cite the low price at which Voya Financial sold its variable annuity book to Athene (the books aren’t remotely comparable: about 85% of the policies in Voya’s block were net liabilities to the company, whereas over 80% of BHF’s are in profit-generating asset position)
  • BHF may have also suffered from a technical overhang as the market digested another variable annuity spin-off from AXA and waited for MetLife to sell its remaining stake
    • MetLife completed the sale in June, but rather than benefitting from the removal of the overhang, BHF stock sank further
  • It now trades at about 37% of book value and less than 5x earnings. Generally when an insurance stock trades this poorly, there is either a large capital hole or an enormous reserving problem. We don’t see evidence of either
  • Yes, BHF would suffer in a large equity sell-off, but so would almost every stock in the market
  • Ultimately, we see capital return as an important trigger to realize value in this investment. The current absence of it, in a sector where most peers pay out 50% or more of earnings as dividends, has left BHF stock adrift without a valuation anchor in a period where financials have underperformed broadly
  • For now, investors are ignoring the large discount to book value and dismiss BHF as “a future story” – but the current 20% earnings yield becomes impossible to ignore once those earnings return to shareholders in the form of cash dividends or stock buybacks

General Motors (GM)

  • This quarter, GM successfully restructured its money-losing Korean operation and announced the retirement of its CFO, whom we viewed as the weakest member of management
  • GM announced that SoftBank’s Vision Fund would invest $2.25bn into GM’s autonomous driving unit (Cruise Automation) at an $11.5bn valuation
  • Softbank performed diligence that validates GM as a technological leader in the field and it could provide strategic assistance going forward. We think SoftBank’s investment would be transformational for GM because it:
    • Funds GM’s remaining investment in Cruise through commercialization
    • Allows investors to value GM as a sum of the parts with an ascribed value to Cruise while eliminating the losses from the traditional OEM business
    • Positions GM to eventually unlock further value through future transactions
    • Gives GM more flexibility to repurchase its undervalued shares
  • The simple math is that with $1bn of losses removed from the traditional business, at a 6x P/E and the Cruise valuation, GM stock could have been re-valued by $11 a share, ascribing no value to SoftBank validating the technology, providing strategic help or receiving favorable economic terms as an inducement to invest
  • Instead while GM stock appreciated $7 in the aftermath of the announcement, it promptly rolled over and gave back most of the gains
  • True, GM faces headwinds from raw material pricing and would be at risk if the supply chain in Mexico is disrupted by a change in government policy
  • Even so, the company made substantial progress this quarter and the shares deserve a better fate

Tesla (TSLA)

  • By all available evidence, the company has had a difficult year
  • Had trouble demonstrating efficient production and it has delayed capital spending which pushes out future growth opportunities in the Model Y and the Semi
  • TSLA is accommodating Model 3 customers who are willing to pay for premium features – making the car more of a luxury item with a smaller addressable market than the mass market car TSLA had promised
  • This high-grading of the backlog combined with the reduction in the government subsidy by early next year, new product delays and the emergence of viable competition for the Model S and X means that 2019 should be a very challenging year for TSLA
  • We doubt entry-level Model 3 will be produced profitably anytime soon, if ever
  • While investors claim to be interested in the long-term growth of TSLA (as the valuation certainly can’t be supported by the current loss-making enterprise), the company is focusing investors on very short-term goals
    • Can the company produce a certain number of cars in a single week through short-term surge production techniques?
    • Can the company fire enough staff and scrimp on capex to show a profitable or cash flow positive quarter or two?
  • On the other hand, we wonder whether surge production techniques to support self-congratulatory tweets are economically efficient ways of ramping production, or whether customers will be happy with the quality of a car rushed through production to prove a point to short sellers
  • We also wonder whether the company’s lack of capital and its determination to show positive cash flow is delaying investments in additional manufacturing capacity and infrastructure necessary to fulfill the bulls’ long-term growth expectations
  • With TSLA’s first-to-market window beginning to close, delaying investment undermines the opportunity. Strangely, the bulls don’t seem to care
  • The most striking feature of the quarter is that Elon Musk appears erratic and desperate. During the quarter, Mr. Musk:
    • Attacked an analyst for asking “boring bonehead questions” on the quarterly conference call
    • Hung up on the head of the National Transportation Safety Board
    • Assailed the media for the audacity to report that Tesla’s customers crash while using “autopilot”
    • Accused an internal whistleblower of “sabotage”
    • Appeared to paint the tape with trivial insider purchases
    • Went on a tweetstorm calling for “the short burn of the century”

Athenahealth (ATHN)

  • Though we have been short for several years, we managed to trade around it such that it has not been a material loser in 2018
  • This quarter, an activist forced out the CEO and convinced the company to put itself up for sale
  • Notably, the activist indicated that it would be willing to pay $160 a share and possibly much more pending due diligence
  • Our take is that the activist has little interest in actually buying the company, but hopes someone else does
  • The risk is that the other buyers realize that ATHN is not a SaaS company, but rather a business process outsourcer in a mature market that already cut costs to the bone last year in response to the activist
  • The prospective buyers might also waver should they conclude that many of the best employees were personally loyal to the now deposed CEO
  • We have used the recent spike to re-short some shares that we covered previously

Greenlight Capital 2Q18 Letter, July 31, 2018

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

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