David Einhorn’s Greenlight Q2 Letter To Investors: Micron Over NetflixVW Staff
David Einhorn’s Greenlight Capital discloses material changes in holdings in 13F filing in his Q2 letter and thinks MU is more valuable than Netflix.
Stay tuned for further analysis.
- Bank New York Mellon (BK) 331K
- General Motors (GM) 9.5M
- Ingram Micro (IM) 1.1M
- Macys (M) 1.7M
- Santander Consumer USA (SC) 2.2M
- Scientific Games (SGMS) 2.0M
- Sunedison Semiconductor (SEMI) 2.7M
- CBI 6.8M, +130% vs prior 2.9M
- KS 1.4M, +61% vs prior 875K
- CNX 20.6M, +55% vs prior 13.3M
- AER 5.6M, +49% vs prior 3.7M
- CFG 12.6M, +25% vs prior 10.1M
- TIME 740K, -81% vs prior 3.9M
- HYH 715K, -70% vs prior 2.4M
- MRVL 9.0M, -63% vs prior 24.7M
- FCB 550K, -59% vs prior 1.3M
- EMC 4.2M, -47% vs prior 8.0M
- LRCX 1.7M, -33% vs prior 2.5M
- NSAM 3.2M, -30% vs prior 4.5M
- NOK 6.5M, -18% vs prior 7.8M
- IACI 2.5M, -15% vs prior 3.0M
- AAPL 7.4M, -14% vs prior 8.6M
- AET 1.3M
- DOX 1.3M
- CRC 2.0M
- GDOT 1.3M
- KMT 2.2M
David Einhorn's Greenlight Capital 2Q15 Letter
The Greenlight Capital funds (the “Partnerships”) returned (1.5)%,1 net of fees and expenses, in the second quarter of 2015, bringing the year-to-date net return to (3.3)%. During the second quarter, the S&P 500 index returned 0.3%, bringing the index year-to-date return to 1.2%.
On April 15 after the close, Netflix (NFLX) announced its results for the first quarter and conducted a conference call. NFLX shares had already risen 39% in 2015 and were trading at more than 100x 2016 estimates with analysts expecting adjusted earnings for the quarter of $0.63. NFLX achieved just $0.36. Prior to the call, the June quarter consensus stood at $0.86; by the next morning consensus was $0.30. All told, analysts slashed estimates for the next three years. Further, we had just finished watching season three of NFLX’s leading original content show, House of Cards, which appeared to be scripted to compete with Ambien.
If you’d told us the news in advance, we’d have guessed it was going to be a bad day for NFLX holders, but apparently Red Ink is the New Black. The shares opened the next morning 12% higher and never looked back. By the end of the quarter, the shares had almost doubled for the year, making NFLX the best performing stock in the S&P 500 by far.
Why did the stock react that way? Cynically: if it soared on bad news, imagine what it would do with good news. Practically: NFLX changed its story and pushed its promises into the distant future, with grand hopes for the decade starting in 2020. It transitioned from being a company judged by how much it earns into a company judged by how much it spends. Whether the spending proves successful won’t be known during the investment horizon of most NFLX shareholders. In today’s market, the best performing stocks are companies with exciting stories where accountability is in the distant future.
Most companies are still held accountable to current performance. Micron Technology (MU), which fell from $27.13 to $18.84 during the quarter, was our biggest loser. It’s a cyclical business and, regrettably, we missed the turn of the cycle. Long production lead times make it difficult to match supply with demand, and when demand falls short (as it has recently), shortages can turn into surpluses. Prices (and profits) fell, and MU disappointed. MU also had manufacturing problems that will impact earnings for the next couple of quarters.
With only three remaining players, the industry is behaving more rationally. Manufacturers are redirecting capacity away from computer DRAM to other segments, and we believe that the excess computer DRAM inventory created earlier this year is now being absorbed. Our assessment is that MU shares have fallen too far. Peak quarterly earnings last year were $1.04 and we expect the cyclical trough to be around $0.40 in the August quarter. At $18.84, the company trades at less than 12x annualized trough earnings and less than 5x prior peak earnings. We expect future cycles will have higher peaks and higher troughs, as the technology story for both DRAM and NAND (including 3D memory) is bright for the next several years.
Our long-term outlook is that sometime in the next few years, MU (currently valued at $20 billion with $3.7 billion of trailing net income) will be worth more than NFLX (currently valued at $40 billion with $240 million of trailing net income). It’s a contrarian view, but we don’t think the movie is over.
Our other significant loser in the quarter was CONSOL Energy (CNX), which fell from $27.89 to $21.74. While natural gas prices were stable during the quarter, coal prices fell about 10%. Near-term this is not a significant concern, as CNX prices are locked in under long-term contracts for almost all of 2015 and about half of 2016-2018 production.
Assuming unhedged forward pricing for coal and natural gas, our long-term resource runoff model values CNX at about $35 per share. This is based on depressed commodity prices and does not give credit for the company’s implementation of zero-based budgeting, which should further improve its position as the low-cost supplier.
From a strategic perspective, the company recently completed an IPO of a master limited partnership for its coal business. Because investor appetite for coal is exceptionally small at the moment, the offering was met with tepid demand. We were able to purchase shares at a 25% discount to the proposed range. The new entity, CNX Coal Resources (CNXC), has an initial dividend yield of over 13.5% and a free cash flow yield of over 17%. At that value, distress is priced in, though it is far from evident that distress actually exists.
On the sunnier side, SunEdison (SUNE) was our only significant winner, as the shares advanced from $24.00 to $29.91. SUNE recently filed for TerraForm Global (GLBL) to go public. GLBL is a renewable energy yieldco located in emerging markets including Brazil, China, India and South Africa. GLBL will provide a new stream of cash flow to SUNE in the form of dividends and incentive distributions, similar to the structure of the existing yieldco TerraForm Power (TERP). Further, earlier this year SUNE acquired First Wind, the largest wind power development company in the United States. GLBL and First Wind add $10-$11 to our sum of the parts valuation.
Greece has been anything but sun-kissed. We continue to hold a small position in Greek bank stocks and warrants. The best we can say is that from the outset we recognized this to be a high-risk, high-reward proposition and sized the position accordingly. Neither our losses nor remaining downside exposure are significant.
Last year, it appeared that Greece had finally turned the corner after years of suffering through imposed austerity and the resultant 25% collapse in GDP. Much like the Seahawks’ ill-fated decision to pass the ball at the end of Superbowl XLIX, instead of giving it to monster running back Marshawn Lynch, Greece snatched defeat from the jaws of victory by electing the populist anti-austerity, pro-debt-writedown, Syriza coalition.
Puerto Rico’s governor recently said of its own debt, “This is not about politics; it’s about math.” The math for Greece is easy: austerity hasn’t improved the economy and its debts are unsustainable. Knowing this, Syriza no longer wanted to play the “extend and pretend” game. Further, Greece’s recently resigned finance minister Yanis Varoufakis believed they wouldn’t have to. Mr. Varoufakis, who kept reminding everyone that he is a professor of game theory, believed that the European leaders would prefer to make concessions now rather than manage the disruption of a Greek default. He must not be familiar with the Tyler Durden school of negotiation: the first rule of using game theory is you do not talk about using game theory. What’s more obvious is that Syriza didn’t understand what the game is.
This is not about math; it’s about politics. Consider that the main difference between Greece and France is that France is a big fan of extend and pretend. And as long as France says it will pay, its bonds might yield just a bit more than Germany’s. Though Greece has a superficially unmanageable ratio of debt to GDP, the debt had been restructured so that there is little debt service burden for the next several years. Politically, European leaders prefer to leave the future problems in the future. Syriza’s refusal to play along is a problem not just for bondholders but also for those holding seats of power. The European leaders fear that if Syriza can claim even a moral victory, it will inspire other European countries to oust their current leaders in favor of populist governments who campaign on the promise of debt repudiation.
Though Mario Draghi promised he would do whatever it takes to save the euro, that doesn’t include lifting a finger to assist Greece financially or in any way signal that the ECB has Greece’s back. Just days prior to the January elections, Mr. Draghi announced that the ECB would exclude Greece from quantitative easing for at least six months. Doing whatever it takes is proving to be a conditional promise, as denying Greece access to the capital markets is a key tenet of the European strategy to pressure Syriza.
For anyone still missing the joke, Bank of Japan Governor Haruhiko Kuroda summarized the view of the global central planners when he said, “I trust that many of you are familiar with the story of Peter Pan, in which it says, ‘the moment you doubt whether you can fly, you cease forever to be able to do it.’ Yes, what we need is a positive attitude and conviction.” Perception supplants reality. The moment leaders (or markets) start making it about the math, gravity comes into play.
The result is that Europe is unwilling to allow Syriza a face-saving compromise, even if that means Greece collapses and the rest of Europe suffers. At this writing, Syriza has capitulated by proposing a deal which leaves Greece with even more austerity than when negotiations began and no actual debt forgiveness. This might not be enough, as the grand populists. The short and macro portfolios had minimal impact on our quarterly result. We presented our new short thesis on oil frackers at the Sohn Investment Conference in May (https://www.greenlightcapital.com/926698.pdf). The response was encouraging as many market participants engaged in the substance of the analysis. However, one sell-side analyst came up with a novel discounted cash flow (DCF) analysis that shows Pioneer Natural Resources (PXD) to be worth $300 per share. Notably, the projections he used to create the DCF are dramatically higher than the projections he used in his earnings model. Talk about keeping two sets of books.
As we were putting this letter to bed, another bulge bracket investment bank upgraded PXD, again with discrepancies between the DCF analysis and the earnings forecast contained in the same report. Perhaps the analysis is colored by this key sentence in the upgrade: “Unless commodity prices rebound sharply we believe PXD will need help from the capital markets to bridge [the] near-term funding gap.”
It was a challenging quarter for finding new long ideas. We managed to find a couple of small long investments in Applied Materials (AMAT) and Bank of New York Mellon (BK).
AMAT manufactures semiconductor capital equipment. AMAT shares fell when it canceled plans to merge with Tokyo Electron over anti-trust concerns. We find standalone AMAT attractive because its core segments of etch and deposition will grow faster than the semiconductor capital equipment market due to the increased use of “multi-patterning” to produce chips at geometries below 20 nanometers. This means semiconductor material must be deposited and etched multiple times to make the devices work, requiring more tools from AMAT and its competitor, Lam Research, in each fab. We expect results to improve, as management turns its attention from the proposed merger to growth and cost savings opportunities. We purchased shares at an average of $20.31, representing less than 12x our fiscal 2016 earnings estimate.
BK is a trust bank with substantial investment services and investment management operations generating stable fee-based earnings. The trust sector has consolidated, leaving BK as one of four global players across most investment services verticals. Following a couple years of poor performance, we believe BK will begin to deliver organic revenue growth and cut expenses significantly. Moreover, a 0.5% increase in short-term rates would substantially increase earnings that currently reflect depressed net interest margins and money market fund fee waivers. In the interim, we expect BK to continue to allocate 100% of its net income to shareholder return with a heavy weighting toward stock buybacks. We bought our position at an average price of $40.61, less than 10x forward earnings (excluding non-cash intangible amortization), assuming the Federal Reserve begins to normalize short-term interest rates.
We have several portfolio exits to report:
We sold the last of our successful long investment in Altice, a European telecom company. Altice did what we expected (acquired SFR, cut costs significantly) and much more (acquired Portugal Telecom for an attractive price, expanded into the U.S.). The market rewarded the over-achievement generously and we were rewarded with a triple digit return in a shorter time frame than we expected.
We sold our long position in Conn’s at a small loss. We entered believing a few bad loans would wash out of the business and leave a healthy, growing retailer. The loan book was harder for the company to control than we anticipated, and for a period the shares declined significantly. The stock recovered when the company announced its intention to sell its loan book. We sold because we weren’t convinced that the company could execute a true exit from the finance business.
We exited our long position in EMC Corp. with a small profit given the reduced odds of any favorable change to the corporate structure and increasing concerns about a lack of growth in the storage business.
We covered our short position in Intuitive Surgical with a small gain. Given its lofty valuation, we were surprised that the market shrugged off repeated earnings misses and weak gross margins. Though we are skeptical of the utility and cost effectiveness of robotics in key surgical procedures where the company expects to deliver growth, near-term expectations have been reduced to achievable levels and we decided to watch from the sidelines.
We sold our long position in Marvell Technology Group. The stock performed well this spring as investors finally began to credit the company for a likely successful outcome in its legal battle with Carnegie Mellon and for a potential monetization of its wireless handset chip business. Given declining demand in the PC market, we didn’t see as much earnings power in the core storage and networking business and decided to sell. By adding to the position in late 2012, when the stock practically collapsed in response to the initial Carnegie Mellon verdict, we achieved a 15% compounded return over several years even though the company repeatedly fell short of expectations.
We acquired our Nokia shares in 2014 after the company sold its handset business to Microsoft. The stock appreciated nicely during 2014 in response to better earnings in its network business and increased optimism around the company’s IP position. When the company announced a confusing merger with Alcatel-Lucent in April this year and the stock rose, we used the opportunity to exit with a healthy gain.
We exited a long-held position in Playtech with a 23% compounded return. The company’s core business in online gaming software remains strong, but a recent acquisition made us question its capital allocation discipline and ability to grow going forward. It seemed better to move on satisfied rather than try to achieve a higher score.
When we shorted Vale in early 2013, it was based on extensive research, but we could have saved ourselves the work by just translating its name from Portuguese into English: Valley. Indeed, both iron ore and Vale have tumbled off their peaks and we covered with the stock down almost 50%.
One of our analysts, Jeremy Weisstub, left the firm during the quarter. He and his wife are moving back to their hometown of Toronto where he will pursue other interests. We thank him for his contributions and wish him success in his future endeavors.
At quarter-end, the largest disclosed long positions in the Partnerships were Apple, CONSOL Energy, General Motors, gold, Micron Technology and SunEdison. The Partnerships had an average exposure of 103% long and 86% short.
“A diamond is a piece of coal that stuck to the job.”
- Thomas Edison
Greenlight Capital, Inc.
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Unless otherwise noted, performance returns reflect the dollar-weighted average total returns, net of fees and expenses, for an IPO eligible partner for Greenlight Capital, L.P., Greenlight Capital Qualified, L.P., Greenlight Capital Offshore, Ltd., Greenlight Capital Offshore Qualified, Ltd., and the dollar interest returns of Greenlight Capital (Gold), L.P. and Greenlight Capital Offshore (Gold), Ltd. (collectively, the “Partnerships”). Each Partnership’s returns are net of the standard 20% incentive allocation.
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