David Einhorn (Trades, Portfolio) presented a short idea at the Sohn conference called Assured Guaranty (AGO, Financial), which is an unusual insurer. According to its website, Assured Guaranty guarantees "scheduled principal and interest payments when due on municipal, public infrastructure and structured financings."
This is extra interesting because Einhorn is well-known for his short of Allied Capital (a private financing company), which ultimately went down. The fight between Einhorn and Allied is chronicled by the investor in the excellent book, "Fooling Some of the People All of the Time."
Einhorn, among other things, said "Pretax income looks likely to collapse."
Income tax before tax has been strong of late.
"The shrinking profits should pressure [share] buyback capacity ... It's a melting ice cube that is paying out the drops while it can," Einhorn said, according to various media reports.
Einhorn posited Assured Guaranty has $7 billion in capital, which it levers up to between 32 and 54 times. The actual number is dependent on how it is measured.
Einhorn added that the company has exposure to Puerto Rican bonds.
Per Einhorn:
"Puerto Rico is the wild card in the AGO story ...The population is no longer growing.
If AGO recognized its much bigger loss [in Puerto Rico], its S&P rating would be at risk. Puerto Rico may be just the tip of the iceberg."
To hedge against the risk of Assured Guaranty not collapsing under the stress of its Peurto Rico debt, Greenlight is buying Puerto Rico debt. If the debt does well and keeps Assured afloat, at least Greenlight is making money on that side.
Assured Guaranty moved fast, as its share price was affected by Einhorn's presentation and immediately released a statement:
“Mr. Einhorn’s analysis of Assured Guaranty fails to acknowledge the positive implications of our significant financial strength and strong operating performance, and demonstrates a fundamental lack of understanding of our business model and the municipal debt markets. In the event of a municipal default, Assured Guaranty is obligated to cover shortfalls in scheduled principal and interest payments only when those payments are due. Our insurance policies do not permit acceleration of payments without our consent. Mr. Einhorn’s focus on total debt service ignores this lack of acceleration, as well as the strength of our balance sheet, and the highly liquid nature of our investment portfolio, which generates significant investment income over time.
Furthermore, Assured Guaranty is well reserved for its municipal exposures and, due to the non-acceleration feature, does not face liquidity risks. We have $11.5 billion of cash and investments1 with $2.8 billion of estimated excess capital over S&P’s AAA level.2 In addition, we have strong legal rights, including for Puerto Rico under PROMESA, which requires that fiscal plans must respect contractual liens and constitutional priorities established under Commonwealth law.
Throughout its history, Assured Guaranty has successfully mitigated potential losses and defended its legal rights in numerous distressed municipal situations, including Jefferson County, AL; Stockton, CA; Hartford, CT; Detroit, MI; and Harrisburg, PA.
For all these reasons and others, we strongly disagree with Mr. Einhorn’s assertions. We remain focused on continuing to generate long-term value for our shareholders.”
In my experience, companies fighting back hard against short-sellers have the most to hide.
If Einhorn isn't right about the weakness of Assured, the stock could well run up quite a bit because it isn't richly valued. GuruFocus data shows it at a price-earnings ratio of 5, forward price-earnings ratio of 13, price-book value of 0.65 and free cash flow ratio of 10. Compared to the broader market or even financials specifically, that's an undemanding valuation. This could mean the market is sniffing out something as well.
David Einhorn is short Assured Guaranty from CNBC.
Disclosure: No positions.
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