It is very important before people make quick judgments that they understand one thing; this article is not a criticism of John Paulson. John Paulson is far smarter than me, and a much better investor, there is simply no comparison. However, John Paulson seems to be mistaken about Bank of America and recently admitted this. Mohnish Pabrai stated at the Value Investing Congress that you can learn a lot from great investors’ mistakes. This is what this article attempts to do.
For anyone unfamiliar with John Paulson, here is a short bio.
John Paulson is the President and Portfolio Manager of Paulson & Co. Inc. Paulson was ranked by Absolute Return Magazine as the 3rd largest hedge fund in the world managing approximately $29bn in merger, event and distressed strategies. Mr. Paulson received his Masters of Business Administration with high distinction, as a Baker Scholar, from Harvard Business School in 1980. He graduated summa cum laude in Finance from New York University's College of Business and Public Administration in 1978. Prior to forming Paulson in 1994, John was a general partner of Gruss Partners and a managing director in mergers and acquisitions at Bear Stearns.
John Paulson became very rich and famous through his short of the subprime market before the house of cards came down. The riveting story is told by Gregory Zuckerman in his latest bookThe Greatest Trade Ever
.
Late last year John Paulson made a very bold call on Bank of America. According to Teri Buhl at Forbes.com link here He predicted Bank of America would have earnings of $3 per share by the end 2012. Using a 10X. multiple the stock would be worth $30 a share.
According to Teri Buhl Paulson predicted:
Net income: $27.2 billion
Shares outstanding: 9.06 billion
Normalized EPS: $3
Value on 12/31/2012: $30.00
At the time I strongly questioned the math used by Paulson in his calculation. On November 25th 2009 BAC was trading at $11.44 per share. On that day I penned an article titled Fair Value of Bank of America: A Flaw in Paulson's Calculation?
The basic point of the article was that John Paulson seemed to be making a major mistake in the amount of shares outstanding. At the time it was only 9.1 billion, but that was when Bank of America owed Uncle Sam $45 billion. It seemed obvious that there were two ways to pay the Government back; by issuing equity or debt. I assumed that BAC would issue both equity and debt to raise enough money to pay back the Government. I assumed BAC would raise approximately $25 billion of the $45 billion in equity. This would increase shares outstanding to 10.2 billion.
According to the latest 10-Q, BAC has over 10 billion shares outstanding. Far more than the 9.1 billion, Paulson assumed in his calculation and much closer to the numbers I predicted.
I did not look at the net income which Paulson assumed would be $27.2 billion, this number seemed to be on the high side. Ravi of http://www.rationalwalk.com/ noted that Bank of America and Merril Lynch’s earnings at the height of the bubble did not reach $27 billion. However, taking Paulson’s number of $27.2 billion divided by 10 billion shares would yield EPS of $2.72 per share.
In addition, I noted that there were many other risks which would directly impact Bank of America’s earnings in the next few years. The economy had 10.2% unemployment when Paulson made his prediction. Although unemployment has declined and the recession is officially over, the consumer has not come back and we are not completely out of the woods yet.
Anyone who has not been living in the forest knows the recent troubles Bank of America has encountered. The New York Federal Reserve and other large investors want BAC to buyback a portion of the $47 billion in mortgages it originated. Bank of America suspended foreclosures in all 50 states.
John Paulson recently came out and admitted he made a mistake. According to Teri Buhl of Forbes ((link here) Paulson now estimates EPS of $2.66 in 2012. However, John Paulson says he is still long BAC, and owns 167 million shares currently.
While Paulson admitted his mistake I was not able to find out if it was due to the dilution effect or that earnings would be far lower. It seems likely that Paulson lowered his estimates due to these recent problems which BAC encountered.
However, Paulson still does not seem to realize that the amount of shares outstanding also will have a large effect on earnings in 2012. Unless BAC buys back 10% of its shares (highly unlikely) it will need to generate close to the $27.2 billion that Paulson now seems to think is unrealistic. Therefore, it seems likely now that BAC earnings will be far lower than Paulson’s current estimate of $2.66. While, I have no idea what earnings will be in 2012 it seems that the current estimates are still too optimistic. This is especially true when taking into account the possible impact of financial reform, and a recovery that increasingly looks very sluggish.
According to Forbes, the cost basis for Paulson’s BAC shares was $9.17. The company is currently trading at 11.44, so Paulson is still up since his purchase. However, I have no idea where Paulson got his new estimates for 2012.
If Paulson or anyone has the answer I would like to know.
Disclosure: No position in BAC
http://www.valuewalk.com/
http://twitter.com/valuewalk
For anyone unfamiliar with John Paulson, here is a short bio.
John Paulson is the President and Portfolio Manager of Paulson & Co. Inc. Paulson was ranked by Absolute Return Magazine as the 3rd largest hedge fund in the world managing approximately $29bn in merger, event and distressed strategies. Mr. Paulson received his Masters of Business Administration with high distinction, as a Baker Scholar, from Harvard Business School in 1980. He graduated summa cum laude in Finance from New York University's College of Business and Public Administration in 1978. Prior to forming Paulson in 1994, John was a general partner of Gruss Partners and a managing director in mergers and acquisitions at Bear Stearns.
John Paulson became very rich and famous through his short of the subprime market before the house of cards came down. The riveting story is told by Gregory Zuckerman in his latest bookThe Greatest Trade Ever
.Late last year John Paulson made a very bold call on Bank of America. According to Teri Buhl at Forbes.com link here He predicted Bank of America would have earnings of $3 per share by the end 2012. Using a 10X. multiple the stock would be worth $30 a share.
According to Teri Buhl Paulson predicted:
Net income: $27.2 billion
Shares outstanding: 9.06 billion
Normalized EPS: $3
Value on 12/31/2012: $30.00
At the time I strongly questioned the math used by Paulson in his calculation. On November 25th 2009 BAC was trading at $11.44 per share. On that day I penned an article titled Fair Value of Bank of America: A Flaw in Paulson's Calculation?
The basic point of the article was that John Paulson seemed to be making a major mistake in the amount of shares outstanding. At the time it was only 9.1 billion, but that was when Bank of America owed Uncle Sam $45 billion. It seemed obvious that there were two ways to pay the Government back; by issuing equity or debt. I assumed that BAC would issue both equity and debt to raise enough money to pay back the Government. I assumed BAC would raise approximately $25 billion of the $45 billion in equity. This would increase shares outstanding to 10.2 billion.
According to the latest 10-Q, BAC has over 10 billion shares outstanding. Far more than the 9.1 billion, Paulson assumed in his calculation and much closer to the numbers I predicted.
I did not look at the net income which Paulson assumed would be $27.2 billion, this number seemed to be on the high side. Ravi of http://www.rationalwalk.com/ noted that Bank of America and Merril Lynch’s earnings at the height of the bubble did not reach $27 billion. However, taking Paulson’s number of $27.2 billion divided by 10 billion shares would yield EPS of $2.72 per share.
In addition, I noted that there were many other risks which would directly impact Bank of America’s earnings in the next few years. The economy had 10.2% unemployment when Paulson made his prediction. Although unemployment has declined and the recession is officially over, the consumer has not come back and we are not completely out of the woods yet.
Anyone who has not been living in the forest knows the recent troubles Bank of America has encountered. The New York Federal Reserve and other large investors want BAC to buyback a portion of the $47 billion in mortgages it originated. Bank of America suspended foreclosures in all 50 states.
John Paulson recently came out and admitted he made a mistake. According to Teri Buhl of Forbes ((link here) Paulson now estimates EPS of $2.66 in 2012. However, John Paulson says he is still long BAC, and owns 167 million shares currently.
While Paulson admitted his mistake I was not able to find out if it was due to the dilution effect or that earnings would be far lower. It seems likely that Paulson lowered his estimates due to these recent problems which BAC encountered.
However, Paulson still does not seem to realize that the amount of shares outstanding also will have a large effect on earnings in 2012. Unless BAC buys back 10% of its shares (highly unlikely) it will need to generate close to the $27.2 billion that Paulson now seems to think is unrealistic. Therefore, it seems likely now that BAC earnings will be far lower than Paulson’s current estimate of $2.66. While, I have no idea what earnings will be in 2012 it seems that the current estimates are still too optimistic. This is especially true when taking into account the possible impact of financial reform, and a recovery that increasingly looks very sluggish.
According to Forbes, the cost basis for Paulson’s BAC shares was $9.17. The company is currently trading at 11.44, so Paulson is still up since his purchase. However, I have no idea where Paulson got his new estimates for 2012.
If Paulson or anyone has the answer I would like to know.
Disclosure: No position in BAC
http://www.valuewalk.com/
http://twitter.com/valuewalk
