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) 📕

Scheidt shot back, “I would say that would be all the more reason to hold it at a lower value because that’s what it’s worth.”

We were quite pleased to hear the SEC so decisively support our view.

Though we conducted the majority of our call without mentioning the company in question, at the end we told Scheidt that Allied Capital had made these and other claims. We asked if it made sense to outline our concerns to the SEC and, if so, to whom should we address them? Scheidt said that we should, and that he was the guy. This was good.

We sent a letter and an eighteen-page summary of our analysis, describing our concerns that Allied was not complying with SEC valuation requirements and abusing intercompany accounting available for controlled companies. We detailed Allied’s responses and the various events that I have discussed here. As a betting person, I felt that Scheidt’s disagreement with Allied’s story made it only a matter of time before the SEC would resolve the dispute—and not in the way Allied’s shareholders hoped.

CHAPTER 9

Fact—or Maybe Not

Off Wall Street is an independent researcher started in 1990 by Mark Roberts that publishes buy and short-sale recommendations. We have been customers for years. It is an expensive, high-quality publication, sold to hedge funds and traditional long-only institutional investors. Unlike most of its peers, Off Wall Street continues to follow up on its ideas and provides substantive updates until it closes out a recommendation. Whether long or short, Off Wall Street is deeply concerned about its track record and treats its recommendations similarly to how serious fund managers treat their portfolios.

On June 12, 2002, Off Wall Street published a twenty-one-page “Sell” recommendation on Allied that highlighted its own conversation with the SEC, an analysis of ASR 113 and ASR 118, and Allied’s white paper. It reviewed a number of Allied’s portfolio companies highlighted in my speech, and wrote its own analysis. Though Allied’s stock had recovered to over $25 per share—or almost all the way back to where it traded before my speech—the shares fell sharply, again, upon the release of the Off Wall Street recommendation.

Part of what was so compelling about Off Wall Street’s analysis was its research into Allied’s largest subsidiary, Business Loan Express (BLX). Allied Capital formed BLX when it bought BLC Financial Services Inc., and merged it with its own SBA lending subsidiary, Allied Capital Express (also know as Allied Capital SBLC). Off Wall Street reviewed BLC Financial’s SEC filings before Allied purchased it and determined that BLC Financial generated 63 percent of its revenue as a public company through gain-on-sale accounting. Gain-on-sale accounting, which allows the recognition of the value of assets when originated, is fundamentally more aggressive than traditional portfolio accounting, which requires recognition of earnings over the life of the assets.

We believed Allied refused to disclose financial information about BLX to conceal its use of gain-on-sale accounting. That accounting, which front-loaded revenue and assumed good loan performance, combined with BLX’s high delinquencies, were a potentially lethal combination. BLX’s earnings were of unusually low quality, and it was probably not generating much cash. This cast further doubts on the appropriateness of the 25 percent interest rate Allied charged BLX. Clearly, Allied used these related-party fees to prop up its income statement.

Off Wall Street also questioned Allied’s $39 million carrying value of its loan to Galaxy American Communications Inc. (GAC). It pointed out that GAC was an affiliate of Galaxy Telecom LP, which went bankrupt and shared the same business address. While there were no public filings on GAC, Off Wall Street’s review of Galaxy Telecom’s SEC filings, which included information about GAC, confirmed that GAC had minimal revenues, lost money, and had more liabilities than assets.

A few days later, Off Wall Street followed up:

We think that the company’s approach now seems to be that it will attack the short thesis with a combination of ad hominem attacks, obfuscation, and specious syllogistic reasoning. A great deal of this approach has to do with the integrity or lack of integrity in using language, and with the use of language to distort and confuse, in our opinion. In the past, we have seen this approach used to good effect in the political arena . . . the integrity of language used might have some relationship to the integrity of the speaker.

Off Wall Street concluded by asking:

By the way, who is writing this convoluted stuff for Allied? And, further, if its accounting is so obviously correct, why did Allied even think it had the need to issue the white paper in the first place, and why does it continue with these new tortured explanations to justify its methods?

We decided to put our analysis on Greenlight’s Web site. We wanted to share it with the public because we wanted everyone to be able to better understand it and to see for themselves how Allied mischaracterized it. I was tired of Allied’s putting words in my mouth, suggesting that my speech had been part of a secretive “whisper campaign,” claiming that we hadn’t done our homework and didn’t know what we were talking about.

As we put the finishing touches on the analysis, Allied announced it would hold yet another investor conference call on Monday, June 17, 2002. I had never before seen a company assemble everyone three times in a month. The Friday before the call I gave a nearly complete draft of our lengthy analysis to journalists who covered or expressed interest in Allied. I thought they would benefit by reading it in advance so that they could have time to prepare informed articles. In fact, none of the journalists wrote about our analysis. Worse, at least one of them passed our draft analysis to Allied.

On the morning of this third conference call, we posted the twenty-seven page report, An Analysis of Allied Capital: Questions of Valuation Technique, and issued a press release containing a summary and offering the public an