Exclusive: An inside look at David Einhorn's "big short"
(Reuters) - Hedge fund manager David Einhorn is taking an even harder line against Green Mountain Coffee Roasters (GMCR.O), his big short trade, claiming a recent audit committee review of the accounting issues he flagged is nothing more than a "whitewash."
In an exclusive interview with Reuters, Einhorn said he still doubts sales figures and spending plans at the company, which saw its stock soar to $110 in August on the rapid growth of its individual coffee servings or K-cups. When Einhorn revealed in October that he had been building a short position in shares of the company for weeks, the stock tanked and it effectively turned things around for his $8 billion Greenlight Capital fund this year.
"I think everything we said in the presentation is right now as it was then -- and in many cases even more so," said the 43-year-old manager, who runs one of $2 trillion hedge fund industry's better-known long/short funds and also is an accomplished poker player.
In the interview with Reuters, Einhorn blasted the company's audit committee for conducting a "whitewash" review of the concerns he raised in an October 17 presentation entitled, "GAAP-uccino." That presentation hit Green Mountain like a tidal wave, and has sliced the stock's value in half to around $46 as of Tuesday trading.
Einhorn's presentation seemed prescient and awoke traders to potential problems with Green Mountain's growth story. Green Mountain reported a massive earnings disappointment in November in another blow to investor confidence. The stock, which had been a favorite of many in the hedge fund set -- most notably John Thaler's JAT Capital -- now ranks as a popular short for managers.
Green Mountain spokeswoman Suzanne DuLong rejected the suggestion the company has given short-shrift to complaints about its accounting practices.
"The audit committee, with the assistance of counsel and a forensic accounting firm, completed its investigation of accounting practices at the company in December 2010," she said. "Most recently, as our CEO and president, Larry Blanford reported in the November 2011 earnings call: 'We are confident there is no misconduct, there is no wrongdoing.'"
In recent years, Greenlight Capital has emerged as one of the more influential hedge fund firms, and Einhorn is one of a handful of savvy traders who can move markets with his "short' calls. Einhorn made his name by warning about Lehman Brothers Holdings Inc's LEHMQ.PK financial health before the investment bank's bankruptcy, and from a long-running battle with the management of Allied Capital Corp (AFC.N), an investment company. A high-profile bid Einhorn made this year to buy a significant minority stake in the New York Mets fell apart this summer -- something of a personal disappointment to the manager who calls himself a lifelong fan of the professional baseball team.
Einhorn would not say how big of a short position in shares of Green Mountain his Greenlight fund still is. But his bet has been something of a life saver for his fund in a difficult climate for many hedge funds. This summer, Greenlight was posting middling returns. In August, for instance, his fund was down 5 percent for the year. Now the fund is up about 5 percent, significantly better than other hedge funds, many of which were down roughly 4.37 percent through November, according to Hedge Fund Research's broadest industry index.
Einhorn hasn't disclosed just how profitable his Green Mountain trade was to his fund. But his talk with Reuters about the trade reveals the manager is clearly sticking to his convictions.
REUTERS: Which of the issues you raised in your presentation do you believe Green Mountain has answered so that you would change them?
EINHORN: "Actually, I think everything we said in the presentation is as right now as it was then -- and in many cases even more so. Some of the things we pointed out, like the inexplicable sales of K-Cups in the June quarter, have now been revealed to have been very valid concerns and the rest remain unanswered. And some of them are things will have to sort of play out in the future like the competition."
REUTERS: Management says that fourth-quarter sales were hurt by wholesale orders, and do not indicate any accounting issues. In other words, you were right, but for the wrong reasons. Were you surprised by the earnings miss?
EINHORN: "The thing about an investment like this is that there are really a lot of ways for us to come out well because the risk-reward for the stock is so poor. And there are so many problems that they don't all have to hit at the same time in order for us to get a good result. In terms of what actually did cause them to miss the quarter? It was largely a sales miss, which seemed to follow from the unexplained sales spike that we highlighted in the presentation."
REUTERS: Management stated, "Though disappointing, we take the recent allegations of misconduct seriously. Our Audit Committee has reviewed the allegations and we are confident there is no misconduct. There is no wrongdoing." What is your response to this?
EINHORN: "Simply saying that you take allegations with misconduct seriously does not mean that you actually take the allegations of misconduct seriously. In other words, their response came only about three weeks after the presentation and there was an enormous amount of material that if somebody was going to take the material comment seriously, they would have to review. It doesn't seem to make a lot of sense to me -- or even be possible -- to think that somebody who took our concerns seriously would even be able to review it in three weeks. As a result, it kind of feels like a whitewash to me. The question at this point, since the company wasn't able to give any substantive answers to the most serious of the questions that were raised -- they instead deferred to a general statement from the audit committee -- the question now becomes whether the audit committee itself is part of the problem as opposed to being a part of the solution."
REUTERS: One of your concerns was that Green Mountain couldn't explain its capital spending. When the company announced earnings, it detailed its capital spending for 2011 and 2012 by category. What did you take away from that?
EINHORN: "I actually think the extra information led further support to our view that the capital spending is unlikely to be going for the purposes that Green Mountain says that they are. In the sense that when you break out the spending, they broke it into various categories.
"For example, they say they are spending $225 million this coming year on portion packs. By our calculation, that would be enough to add approximately 15 billion K-cups of annual capacity. And yet the company only needs to add about 4 billion cups of capacity. So there is a rather large delta there. But the clearest one of all (involving Green Mountain's capital spending) actually is the manufacturing facilities where they said that they are going to spend $175 million. They said the big pieces of this are at their expansion in Virginia and in Ethics, Vermont. We went into the various property records and the building permits relating to these kinds of expansion and we were only able to total in those properties -- and actually including another property in Waterbury, Vermont -- we were only able to find about $50-60 million of capital spending on the pieces that they say are the biggest pieces of the $175 million facilities and infrastructure spent.
"All of this adds together to leave us with the view that it is very unlikely that they have an adequate explanation for where approximately $665 million of capital spending can reasonably go to support the growth of this business."
REUTERS: After Green Mountain announced earnings, there were a raft of insider purchases. Is this a bullish signal for the stock?
EINHORN: "This is something that we see in a number of these types of positions, where when there is an effort by a management team to promote the stock they go and get a large number of insiders to make what we call nominal purchases or to use a term of art to 'paint the tape.' But what's interesting here is that you have a team where they've literally sold stock in the hundreds of millions of dollars -- and are buying back stock in the hundreds of thousands of dollars.
"In the more clear example of this, Michael Mardy (Director) sold 20,000 shares for $97.48 on August 5, 2011. He purchased 1,000 shares for $43.36 on November 14, 2011. David Moran (Director) sold 10,000 shares for $98.50 on August 5, 2011. He purchased 1,180 shares for $42.17 on November 14, 2011." (A Green Mountain spokeswoman said the August insider sales were part of a previously arranged share selling program.)
REUTERS: What's fair value on Green Mountain stock?
EINHORN: "I don't think there's any way to know for sure what the fair value is. When I think about this company, I think about the cash flow that it generates. And right now, the company should be in a fantastic position because it still has the monopoly on the ability to make K-cups. And despite that, the company has no cash flow from operations and has substantial capital spending. So it seems to me that a business that doesn't generate any cash -- and this is before the monopoly position on the K-cups disappears next September -- if you don't generate very much cash, it's hard to understand why there is a large value."
(Reporting By Jennifer Ablan; editing by Matthew Goldstein and Edward Tobin)