John Paulson is the President and Portfolio Manager of Paulson & Co. Inc. He was ranked by Absolute Return Magazine as the 3rd largest hedge fund in the world managing approximately $29 billion. Prior to forming Paulson & Co in 1994, John was a general partner of Gruss Partners and a managing director in mergers and acquisitions at Bear Stearns. Paulson & Co portfolio manages about $20.46 billion to-date.

John Paulson, a former mergers and acquisitions banker, established his firm as a merger arbitrage hedge fund manager, seeking to make money from situations when one public company announces plans to take over another. Merger arbitrage hedge funds primarily study equity markets, but they also research the market for credit default swaps (CDS).

Newsweek’s article, The Greatest Trade Ever, wrote Paulson “earned a place alongside George Soros and Warren Buffett as an oracle of investing.” Beginning in mid-2006, John Paulson gambled against the housing market by buying up CDS contracts. These moves made him $15 billion in 2007 and $5 billion more in 2008, when the S&P500 had historical losses. In fact, his clients even thought the annual report of 66% profit gain sent out in Feb 2007 had a typo.

A beginner investor like me then questions: What is CDS? How did it give Paulson $20 billion pay-off in 2 years? Many investors think of CDS as a form of insurance that starts paying out as soon as a credit security falls in value. This is an incomplete understanding of how CDS works.

The modern CDS was renovated by bankers from JP Morgan Chase in 1997. In the simplest case, three parties could take part in the process: CDS buyer, bank or seller of the CDS, and the company being speculated. Buyers pay annual premium to the seller until contract ends, or until speculating company defaults. In an event where the speculated company defaults or drop in credit rating, CDS buyer will receive payment from the CDS seller. There is an important difference between CDS and insurance. The insurance buyer usually has a stake in the speculated company, but the CDS buyer does not have to have interest in the speculated company. The premium paid or the “spread” is determined by the pay-out value upon default, and likelihood of the default. The investor or buyer of CDS can make money in two ways. Investor can wait to receive pay-out once default occurs. In Paulson’s case, he began buying up CDSs when it was fairly cheap (narrow spread) in 2006 and sold the CDSs when the spread widened. So, CDS can either offset losses or act as another venue for investors.

In the quarterly report to shareholders, Paulson said that he thinks financial stocks like Bank of American may double by 2011. He believed that banks are inefficiently valued and there “are opportunities on both the long and short side.” For 2008-2009, Paulson’s focus had been on financials, “long distressed opportunities” i.e. mortgages, bankrupt debt, capital restructuring, and “strategic merger deals” i.e. Wyeth. In 2008 Paulson Fund report, the company wrote, “Goldman Sachs recently estimated total US losses in this cycle of $2.1 trillion, as compared to realized losses to date of $1 trillion, indicating we’re only halfway through the crisis.” The Paulson team predicted the “distress opportunity” of the mortgage defaults, financial institution debts, and corporate debts to total $10 trillion.

Also, the flattening dollar has pushed many investors like Paulson towards gold. See Paulson Co 3Q Letter: (pg 14) “Due to our positive outlook for gold we wanted to have some exposure to the sector. Our current exposure consists of five gold mining stocks, comprised 14% of our current portfolio.”

Paulson’s current top holdings reflect his focus in risk arbitrage, gold, and financials.

No.	Company	Weightings	Shares
1	Spider Gold Shares (GLD),	15.22%	31,500,000
2	Bank of America Corp. (BAC)	13.21%	159,794,229
3	Wyeth (WYE)	12.27%	51,694,300
4	AngloGold Ashanti Ltd. (AU)	8.54%	42,849,864
5	ScheringPlough Corp. (SGP)	7.95%	57,621,600
6	Citigroup Inc. (C)	7.10%	300,000,000

Paulson Funds	2008 Annual Returns		Standards	Return
Partners	6.28%
International	7.87%
Enhanced	12.55%		Event Index	-22.1%
Partners Enhanced	12.65%		HF Index	-23.3%
Credit II	16.30%		Distressed	-30.7%
Credit	18.50%		S&P500	36.9%
Advantage Plus	24.00%		DowJ Euro	-45.6%
Advantage Plus	37.60%

High Growth Companies:

Capital One Financial Corp. (COF) 2.97% Weightings

Capital One Financial has a market cap of $17.15 billion; its shares were traded at around $37.7 with and P/S ratio of 0.96. The dividend yield of Capital One Financial Corp. stocks is 0.53%. Capital One Financial Corp. had an annual average earning growth of 16.3% over the past 10 years.

In the latest press release, CEO of Capital One said company will expect higher defaults throughout 2010. The company’s charge-offs increased to 9.64% for 3Q from 6.13% same period prior year. Capital One plans to sell $1 billion in 30-year trust preferred securities. 3Q earnings rose 13.8% from $374.1 million in 2008 to $425.6 million in 2009.

John Paulson owns 17,000,000 shares as of September.

Boston Scientific Corp. (BSX) 5.13%

Boston Scientific Corporation is a Massachusetts-based developer, manufacturer and marketer of minimally invasive medical devices. The company has a market cap of $12.2 billion; its shares were traded at around $8.09 with a P/E ratio of 14.19 and P/S ratio of 1.51. Boston Scientific Corp. had an annual average earning growth of 11.6% over the past 10 years.

The company plans to relocate from Doral, Massachusetts to Costa Rica over the next 3 years. Boston Scientific said it will pay $296 million in court settlements for its subsidiary, Guidant uniThe. $294 million of the charge will be reflected in the 3Q earnings report. The investigation for failed heart devices began before Boston Scientific acquired Guidant. 3Q 2009, Boston Scientific lost $94 million or $0.06 per share, compared to $250 million profit or $0.13 per share a year ago. The company’s heart-stent was approved in Europe.

John Paulson owns 99,135,000 shares as of September.

Low P/E John Paulson Stocks

Conseco Inc. (CNO) 0.09%

Conseco, Inc. provides health insurance, life insurance and annuities. Conseco Inc. has a market cap of $929.98 million; its shares were traded at around $5.03 with a P/E ratio of 5.35 and P/S ratio of 0.22.

The company announced it has completed reinsurance contracts with Wilton Reassurance Co for 237,000 policies. In the deal, Wilton plans to give $45 million in commission to Conseco. Conseco reported it might sell up to $230 million of stock to payoff the $854.6 million debt.

John Paulson bought 3,600,000 shares for $5.26 per share. Paulson Co is involved in the Conseco’s restructuring and bankruptcy management. Paulson’s 3Q report (pg 14), “we have significant debt positions in numerous bankrupt companies that will convert into equity stakes when the companies emerge from bankruptcy…from past experience, these post-bankruptcy equity stakes can be meaningful source of return.”

Sunstone Hotel Investors Inc. (SHO) 0.14%

Southern California-based Sunstone Hotel Investors, Inc. owns hotels in upscale segments under names: Marriott, Hilton, InterContinental and Hyatt. The company has a market cap of $558.51 million; its shares were traded at around $7.43 with a P/E ratio of 5.85 and P/S ratio of 0.58.

The real estate trust will publicly offer 20 million of its shares at $7.20. Sunstone Hotel will default on its mortgage debt on a San Diego W Hotel ($65 million), and Marriott Ontario Airport Hotel ($26 million).

John Paulson bought 3,976,000 shares in the quarter that ended in September.

Wyeth (WYE) 12.27%

Wyeth develops and markets pharmaceutical and health care products companies. The company operates under the names: Wyeth Pharmaceuticals, Wyeth Consumer Healthcare, and Fort Dodge Animal Health. Wyeth has a market cap of $64.32 billion; its shares were traded at around $0 with a P/E ratio of 13.57 and P/S ratio of 2.82. The dividend yield of Wyeth stocks is 2.49%. Wyeth had an annual average earning growth of 5.8% over the past 10 years.

Wyeth has been acquired by Pfizer recently.

Pfizer will be grant its CFO Frank D'Amelio $1.2 million, and biopharmaceutical leader Ian Read $1 million in cash and stock for completing the purchase of Wyeth. Pfizer cut costs for the 3Q and profits rose 26%. Pfizer took a $22.5 billion loan to complete the $68 billion acquisition of Wyeth. Wyeth is known for developing biotech drugs, vaccines and antidepressants.

John Paulson owns 51,694,300 shares as of September. In the 2009 3Q performance report (pg 4), the company wrote, “The most profitable deal in the quarter was Pfizer’s $64 billion acquisition of Wyeth. Our profit was due to accretion of the spread from inception through closing on October 15th.” As a result, Paulson Co. became the second largest holder of Wyeth. Wyeth shares are concentrated in the Merger and Advantage funds.

Paulson Funds Performance Summary for 2009
Type	Fund name	YTD Return
Merger Arbitrage	International	5.22%
	Partners	5.13%
Merger Arbitrage	Enhanced	10.96%
(2x weighting)	Partner Enhanced	10.50%
Event Arbitrage	Advantage Ltd	13.05%
	Advantage LP	13.08%
Event Arbitrage	Advantage Plus Ltd	19.74%
(1.5x weighting)	Adv. Plus LP	19.61%
Credit Funds	Opportunity Ltd	23.14%
	Opportunity II Ltd	23.15%
	Opportunity LP	23.15%
Recovery Funds	Recovery Ltd	19.89%
	Recovery LP	19.97%

Sources:

Paulson Co. 3Q Report
Paulson Co. 2008 Report

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