(GuruFocus, October 26, 2009) David Einhorn of Greenlight Capital published his 3Q09 letter to partners. For the quarter, the three funds he managed returned 7.0%, 5.4% and 4.8%1 net of fees and expenses, respectively; and year to date they returned 30.0%, 26.2% and 22.9%.
Einhorn outlined both the bull case and the bear case for the equity market, and stated “both sides seem to make sense and we find ourselves agreeing with proponents of each depending on the day”. He runs on a long/short strategy and is currently 99% long and 59% short.
Also Einhorn pointed out that the bull market has been so far the professional managers’ market with individuals sidelined or piled money into bond market. He said there are plenty of sellers including corporate and company insiders. Einhorn clearly does not believe the stock market rally can be sustained because money went into the bond market may not come back to equity market.
On the individual stocks and bonds, he commented on three names that he added during the quarter: Cardinal Health (CAH, Financial), CIT Group (CIT, Financial) debt, and Rheinmetall AG (Germany: RHM).
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Einhorn outlined both the bull case and the bear case for the equity market, and stated “both sides seem to make sense and we find ourselves agreeing with proponents of each depending on the day”. He runs on a long/short strategy and is currently 99% long and 59% short.
Also Einhorn pointed out that the bull market has been so far the professional managers’ market with individuals sidelined or piled money into bond market. He said there are plenty of sellers including corporate and company insiders. Einhorn clearly does not believe the stock market rally can be sustained because money went into the bond market may not come back to equity market.
On the individual stocks and bonds, he commented on three names that he added during the quarter: Cardinal Health (CAH, Financial), CIT Group (CIT, Financial) debt, and Rheinmetall AG (Germany: RHM).
Cardinal Health (CAH)
CAH distributes pharmaceuticals and medical products and manufactures medical equipment and related disposables. CAH’s businesses have und CareFusion (“CFN”), its higher margin and relatively higher growth medical equipment business. At its Investor Day this June, CAH’s new management team announced a reduced operating outlook and high spin-off related ‘dis-synergies’. In response, Street analysts sharply reduced their fiscal year 2010 EPS estimates and the share price weakened. The Partnerships established their position in CAH at an average price of $30.22 per share, representing 11x the reduced fiscal 2010 consensus Street EPS estimate of $2.75 (down from the $3.51 in EPS reported for fiscal 2009).
We expect CAH to exceed earnings expectations over the next few years due to margin improvement initiatives, new product introductions, reduction of investment spending, a strong generic drug cycle and stabilizing hospital capital spending trends. On September 1, CAH completed the spin-off of CFN. Following the spin-off, the new management teams at both CAH and CFN have received significant stock incentives in their respective companies. CAH shares, including the pro rata value of CFN shares, ended the quarter at $37.70 each.
CIT Group (CIT) Debt
CIT is the 28th largest bank holding company in the U.S. with $71 billion of primarily finance and leasing assets. As credit markets tightened in the summer of 2008, CIT lost its ability to refinance its debts. With its near-term debt maturities exceeding the runoff from its loan portfolio and the government deeming CIT “too-small-to-save”, rumors of bankruptcy swirled this summer and bond prices fell from the 70s to the low 50s. The
Partnerships established their position in CIT bonds at an average entry price of 52% of par. At this price, we believed we were creating a $71 billion balance sheet for $46 billion, representing a 35% discount.
While losses will clearly be higher in 2009 and 2010 than CIT’s 3% loss reserves given economic conditions, we expect unsecured recoveries to exceed 85% of par on our bonds under an orderly wind-down scenario. The bonds ended the quarter trading at 61% of par.
Rheinmetall AG (Germany: RHM)
RHM is a German defense and automotive engineering group. The Partnerships
established their position in RHM at an average cost of €38.32 per share, which we believe represents a healthy discount to the sum of the values of its defense and automotive businesses. RHM’s defense business of niche troop protection applications has a substantial pipeline of high-tech products, and a variety of promising development opportunities. Management is confident that the defense business can generate double digit growth in sales over the medium term. This unit could contribute €2.75 per share in
earnings in fiscal year 2010, enough to justify the value of the stock, thereby creating the automotive division for free. RHM’s automotive business, focused on a variety of OEM applications, has suffered from pressures in the global automotive markets. However, management has garnered substantial wins in process and workforce restructuring, and RHM should now emerge out of the current cycle with an improved competitive position.
The automotive business, with almost €40 per share in revenue, should provide substantial additional value. RHM shares ended the quarter at €40.46. Currently, we continue to have a low net long exposure to equities. We believe that both our long and short portfolios have good potential and we could actually do nicely on both sides should we reach a point where the market stops its one-way behavior.
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