Fooling Some of the People All of the Time, a Long Short (And Now Complete) Story, Updated With New by David Einhorn (tohfa e dulha read online TXT) 📕

per share. Allied took $425 million of unrealized depreciation during the quarter, including a $152 million loss on its BLX loan guarantee. During the quarter, Allied sold its last remaining flower, Norwesco, for an $87 million gain. The earnings press release announced that Allied “currently anticipates that 2009 dividends will be reduced to a level that more closely approximates net investment income.”

The conference call to discuss the quarterly result brought only more bad news for shareholders as Walton announced, “We have made capital preservation our highest priority.” Allied would cut more costs, reduce staff, and “favor further deleveraging our balance sheet over making new investments.”

Sweeney added: “We also plan to seek an amendment to our net worth covenant with our private lenders during this quarter as the depreciation we experienced in the third quarter reduced our excess margin on this covenant . . . we may see additional depreciation in the portfolio.” Had Allied taken an additional $40 million in write-downs, it would have violated the covenant that quarter. Perhaps it held off taking the “additional depreciation” to avoid that event. As it was, paying the fourth-quarter distribution would put Allied in violation of the covenant.

On the quarterly conference call, an analyst asked whether Allied might try to raise equity through a rights offering to cure the default. Penni Roll, Allied’s CFO, explained, “You can look at a decrease in the dividend as almost like a rights offering in a sense because it has a similar effect in that not as much capital leaves the company and it’s being done with the incumbent shareholder group.” Somehow I doubted the individual investors who had bought shares at the top of the Allied pyramid would see it that way. Ironically, Roll’s statement is actually true but completely at odds with Allied’s multiyear propaganda regarding the meaning of equity raises and shareholder distributions. Allied finally admitted what I had been saying all along: Raising capital and paying dividends were related events—all part of a capital replacement cycle.

Walton finished his remarks by announcing, “The Board has asked Joan [Sweeney] to delay her retirement and she has agreed to remain our Chief Operating Officer.” I guess Allied decided that Sweeney didn’t need to retire after all.

Allied’s share price, which had recovered to $7.30 heading into the announcement, resumed its descent, closing under $2.00 on November 20, 2008. This brought on yet another round of paint-the-tape buying as more than a dozen insiders ponied up relatively small dollar amounts for between 1,500 and 15,000 shares. Walton sprang for a full week’s pay—almost $100,000—to buy 40,000 shares at $2.27 each.

On New Year’s Eve, Allied announced that it had amended its credit agreement with its banks. The minimum net worth covenant was reduced, but Allied still needed to maintain the 1:1 debt-to-equity test. In exchange for the amendment, Allied agreed to the following conditions: It would pay a small fee; pay a higher interest rate on its bank loan; and, by January 31, 2009, pledge a first lien on all its assets to its lenders. This last condition would allow the banks to take control of Allied’s investments if Allied went bankrupt. Allied also agreed to limit shareholder distributions to $0.20 per quarter through December 2010.

Never one to admit defeat, Merrill Lynch analyst Faye Elliot pounded the table once more: “Debt renegotiation terms better than expected. Buy.” The stock doubled to $4.80 by January 6, 2009.

When I learned of the New Year’s Eve amendment reinforcing the 1:1 debt-to-equity ratio limitation, it made no sense to me. Allied knew, or should have known, it would fail to comply with the new agreement almost immediately. With its distribution of an additional $0.65 per share to stockholders in December, combined with the post-Lehman deterioration in the capital markets, it was a near certainty that Allied would violate the ratio when it released its year-end balance sheet.

That truth hit home on January 28, 2009, when Allied announced it would again “re-open” negotiations with its lenders. Allied reneged on its promise to pledge its assets to the lenders by January 31. Allied defaulted under its amended agreement, which ended its ability to make further distributions to shareholders. And with Allied shares falling to $1.91 each, even Merrill Lynch’s analyst finally threw in the towel and downgraded Allied’s stock rating to “underperform.”

In February 2009, Allied announced that it was in formal default and sought a “comprehensive restructuring” of its debt. The shares spun lower, reaching $0.59 each—a price lower than the prior quarter’s distribution.

The year-end results announced in March 2009 were anticlimactic. Since Allied no longer needed to play the “taxable earnings” game, there was no need to defer realized losses—$142 million of which appeared that quarter. The total loss for the fourth quarter was $579 million. Now, Allied had $1.95 billion of debt and only $1.72 billion of equity ($9.62 per share). During the year, Allied paid out $456 million in shareholder distributions and lost $1 billion.

Allied discontinued its proprietary loan grading system because, according to Roll on the year-end earnings conference call, it was “no longer useful as a tool to measure portfolio quality.” She noted that there were many investments that would experience some loss if Allied sold them just then, but that might perform as expected if held to maturity.

Amazingly, even these write-downs didn’t seem particularly aggressive. Allied acknowledged that the collateralized loan obligation market had come to a complete stop. Yet it still carried its investment in Callidus, a company with a business that solely created and managed CLOs, at a sizable unrealized gain. Allied valued its $376 million of junior interests in CLOs (it had continued to add to the portfolio even as the crisis escalated) at $265 million at a time when comparable assets traded for just pennies on the dollar. Incredibly, bankrupt BLX, where Allied had increased its investment by buying out the banks, was still listed as worth $105 million.

There would be no carryforward income into 2009 and no expected distributions to shareholders. March 2,