What's Ken Heebner Investing in Now?

Seeking Alpha has a post going over some of Heebner's current top picks. Worth checking out, even if (like me) you think investing in financials like Citigroup is madness.

You Can't Blame David Einhorn

As the recently released transcript of David Einhorn talking to the CEO of Punch makes clear, David Einhorn was right to sell out of the company. Here's an excerpt of the phone call:

PUNCH CEO: Well, I -- I think -- I -- I think the market sort of dictates this. I don’t think it’s a matter for the market to dictate that. We -- our view is simple, that is, that, you know, we have to make sure that we can preserve a sensible headroom to the covenant from a securitisation and -- and take out the convertible as the -- the maximum and minimum requirement of any discussion. But there’s absolutely -- if you go back over the history, and I know -- I -- and I -- and I perfectly respect that you’ve not been involved from the beginning, but when we originally floated the company, we did an initial public offering of 116 million pounds. We have only done since that time --, that’s 161 million pounds. We have only done, since that time, 175 million pounds [inaudible]. So, to be absolutely clear, I don’t -- I don’t look at the business from an equity perspective and if -- you know, and it’s not my intention to over-equitise this business whatsoever. The transactions that we’ve done, for example, we’ve shown, pretty substantially dispassion in what we’ve sold to ensure that we maximise value on the debt and, so this -- so it’s merely about making sure that -- and we can turn around to the shareholders and say, “Actually, anything that we do is sufficient to give ourselves a – headroom for a considerable period of time into the future and also addresses the convertible”. That’s the maximum and that would be the minimum that would be worth considering.

DAVID EINHORN: Mm hmm. So, would you -- as you pencil that out, what do those amounts turn out to be?

ANDREW OSBORNE: Something like 350 sterling.

DAVID EINHORN: 350 million sterling?

ANDREW OSBORNE: If you were -- if you were to roughly sort of work on the basis that you kinda took out the -- the converts, and that’s something that gives you, say, 10 percent headroom in within both of the covenants, filed covenants.

DAVID EINHORN: Wow, wow. That would be shockingly horrifying from my perspective. Can you sell half the company just at a buck and a half -- a Euro -- a pound and half? Oh, no.

ANDREW OSBORNE: So those proceeds are applied to buying back debt at say 60 in the pound and remember any --

DAVID EINHORN: Who cares -- --

PUNCH CEO: [inaudible].

DAVID EINHORN: -- who cares, who cares, after a year of going through this, now we’re going to dilute ourselves like this. Oh, no.

ANDREW OSBORNE: Why do you get diluted?

DAVID EINHORN: Because you doubled the share capital almost.

PUNCH CFO: Yeah, but [overspeaking]...

Consider what Einhorn just heard. He just heard the CEO of a company he owns a large amount of equity in tell him that he doesn't view the business from the perspective of an equity holder. Later on, the CEO doesn't even appear to understand how nearly doubling the share count will dilute current equity-holders.

I'd sell as many shares as I could after that conversation, assuming I owned any. To the point, however, Einhorn has no duty to other shareholders to not sell shares of a company when he learns something such as this affecting Greenlight's investment.

The only person in a fiduciary position here is that CEO. You can blame him for being an idiot many times over. But you can't blame Einhorn--or at least shouldn't.

Marty Whitman Quotes (from Third Avenue's Recent Letter)

Third Avenue's latest shareholder letter is a great read.

At its start, Marty Whitman basically provides a condensed view of his book, Value Investing: A Balanced Approach--which serves as either a nice teaser for those who haven't read the book or a nice refresher for those who have.

Throughout the letter, a number of one-liners are made. Whitman points out, for example, that "analysts really ought not to use the word 'risk' without putting an adjective in front of it." Similarly, he says, "Economists have it wrong when they say, 'There is no free lunch.' What they should say is, 'Somebody has to pay for lunch.'"

Later, James Montier is quoted saying, "The idea that the risk of an investment, or indeed, a portfolio of investments can be reduced to a single number is utter madness." And Thomas LaPointe observes that, "A disorderly Italian default would be at least ten times greater than a Lehman Brothers event."

Anyhow, there's much more in the letter; you can read it here.

David Sokol on Minimizing Mistakes

SFGate recently reported on the management philosophy of David Sokol, one of Buffett's highly-praised business managers. While noting that details can be found in Sokol's book, Pleased but Not Satisfied, the article itself summarizes a few of the lessons. Regarding minimizing mistakes, for example, it says:

In Sokol's mind, operational excellence consists of paying attention to detail and minimizing the making of mistakes or other small problems that could turn into big issues. For example, some oil companies have been cited numerous times for a lack of attention to seemingly small manners, and that have resulted in oil pipeline leaks or oil well explosions. In many cases, these damaging events might have been less severe, or could even been prevented with attention to seemingly minor maintenance activities. Because of a lack of attention to detail, the last oil company might experience huge declines in its reputation and profits. Openness and candidness are other key ingredients to excellence, according to Sokol. In his words, "the more uncomfortable the situation, the more valuable a candid conversation becomes."

There's nothing revolutionary there; it's really just the basics. But actually doing what is "basic" is another story. And Buffett loves those who do the basics well, decade after decade.

Short Stocks Like David Einhorn?

Business Insider recently linked to an interview with David Einhorn in which he lays out how he short stocks--or at least how he did it in this past financial crisis. Here's the relevant section:

Interviewer: Okay. I guess I want you to continue to sort of chronologically in August of ’07, as you said you see BNP Paribas freeze redemptions and that gives concern and you’re talking to the rating agencies among other things and you’ve identified the type of companies that you had concerns about. Can you just sort of take us through chronologically through the end of ’07 and into ’08 and how things changed, if at all, for you folks?

David Einhorn: Yeah absolutely. So this is sometime in August, we put on a bunch of positions and our team here basically divided up the names for sort of further work cause we wanted to figure out which were the ones that were the most exposed. Whereas the initial couple dozen was ticked off relatively quickly over the course of a weekend, which is not our normal amount of time to [do] due diligence, but I felt that given what was going on, there may not be a lot of time. And so we began putting on those couple dozen positions a little faster than we ordinarily would if we were just researching an individual security.

So from there we began concentrating our work and trying to figure out well which were the better, more exposed companies and which were the less exposed companies and over the course of the next couple of months, we focused the list down and we covered a number of the shorts and we increased a number of the shorts as we focused on the people that we thought were most vulnerable.

In sum, Einhorn quickly shorted a group of businesses in an industry with problems, worked feverishly to differentiate the worst of that bunch from the best, and then covered his shorts or added to them accordingly. You can check out the rest of the interview at Santangel's Review.

Third Avenue Discusses their Leucadia Investment

In the latest annual report for Third Avenue Value, Amit Wadhwaney discusses his fund's investment in Leucadia. Here is the relevant excerpt:

Leucadia National Corp. (“Leucadia”) is a NYSE-listed holding company. Run by Ian Cumming and Joe Steinberg since its founding in the late seventies, Leucadia has compounded the NAV of its portfolio by about 18.5% per annum, on average, over the last 30 years.

Given such a long-term track record, it is hardly surprising that Leucadia’s stock has rarely been inexpensive. There have, however, been opportunities to purchase these shares at attractive valuations following sizable double-digit declines in stated book value, as occurred in 1999 and 2008. In 2008, mark-to-market losses on several of its investments resulted in a decline of over 55% in its stated book value. The company also took sizable accounting write-downs to its deferred tax asset. The resultant negative impacts on reported earnings and book value drew the ire of the market at large, and the company’s stock price plummeted to what we deemed to be unusually attractive levels.

While the mark-to-market declines and writedowns in these various assets conformed to accounting standards, the resultant declines in reported earnings and book value pushed many investors to the exits and provided us with precisely the type of opportunity that we look for – a short-term distraction which allowed us to partner, at bargain prices, with a management team which has proven its ability to grow NAV at truly exceptional rates over the past 30 years.

It was not particularly surprising that Leucadia recognized substantial accounting losses during the depths of the financial crisis, in early 2009. Its portfolio included equity and royalty interests in a large-scale, Australian iron ore mining operation and another base metals mining company, the market values of which had declined reflecting expectations of poor near-term profitability. In addition it held significant investments in a U.S.-based, full-service investment banking and securities firm, which, while its security price declined during the financial crisis,

had employed its strong balance sheet to expand its work force and build its market presence during a period when its competitors closed shop or retrenched. Our conclusion was that these reported losses did not represent a true permanent impairment to the underlying businesses and the long-term fundamentals of the businesses remained attractive.

Additionally, the sizable write-downs of deferred tax assets, which exceeded $1.5 billion in 2008 alone, were prompted by a mechanical interpretation of accounting law; but, had neither any negative effects on cash-flow, nor, we suspected, any longer-term economic repercussions. Presumably, when business conditions were to moderate, these substantial tax assets would once again be available to provide protection from taxes on future realized investment results; and given the aforementioned track record of the company, we believed that the odds of Leucadia delivering value realization in the future were in our favor.

Let us look more closely at these mark-to-market writedowns which helped spark a sell-off in Leucadia’s share price. Did they instill widespread fear in the market? Yes. Would such write-downs be undeniably unpleasant, if not downright scary, for those investors/speculators with shortterm time horizons and/or leveraged portfolios? Certainly. But from Third Avenue’s perspective – that of a long-term, fundamental investor which does not employ financial leverage – these accounting write-downs were merely distractions from the key factors in our analysis, and largely irrelevant to the consideration of economic book values which were considerably longer term in nature.

We find a bit of irony in that last point; specifically, that the environment which scared many investors out of Leucadia stock was precisely the type of environment in which Leucadia has historically been able to sow the seeds of long-term value creation. This point is one that should be clear to anybody who has analyzed Leucadia’s history, but also one which was, to many, drowned out by the noise of reported accounting statistics and general market anxiety. In this case, such noise ultimately lacked relevance to the fundamental, long-term health of the underlying business, and to the key factors which played into our decision to invest. Among these factors were the unusually cheap valuation at which we were able to invest, the longterm track record of value creation and the aforementioned exceptional tax attributes.

As usual, Marty Whitman and the rest of the Third Avenue team not only give you a lot of insight into their own picks but also into the mechanics of good investing. You can read the full report here.

Was Buffett's 1984 Prediction Proven Correct?

In a speech arguing that the efficient market theory is bogus, Warren Buffett identified 9 fund managers who he said would beat the market.

He claimed he didn’t pick these people because they already had an outstanding track record. He said he selected these people years ago based upon their framework for investment decision-making. Of course finance professors didn’t believe him, and many questioned his motivation. Warren Buffett was arguing that markets were inefficient, whereas professors were arguing they were.

That speech was back in 1984. Who was correct--Warren Buffett or the finance professors?Insider Monkey has the score at Business Insider.

Update: Fooling Some of the People

A bit over a year ago I pointed to my review of David Einhorn's book Fooling Some of the People All the Time, saying that you could read the opening paragraphs online. Since that time, Einhorn has linked to that review from the book's website and the editor of The Objective Standard has allowed the review to be read in full online. Enjoy!