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) 📕

editor suggested I write a letter to the editor, which I did. They printed a portion of it a couple of weeks later under the headline “Our Short Position in Allied Capital.” I wrote:

We are writing in response to Holman Jenkins’s . . . [July 2 Business World column] regarding our short position in Allied Capital . . . We are not critical of Allied because we are short and have an agenda; we are short because there is a lot to criticize at Allied.

For example, Allied does not carry its assets at fair-value as defined by the SEC’s interpretation of the Investment Company Act of 1940. We identified approximately 35% of Allied’s portfolio that appears to be carried above fair-value, because Allied uses the Small Business Administration’s (SBA) more liberal valuation policy, rather than the SEC’s. Allied generates low quality earnings through non-arm’s-length dealings with unconsolidated subsidiaries such as Business Loan Express, even as Business Loan Express’s portfolio has deteriorated. Allied has responded that the SEC rules are “difficult, if not impossible to apply” and “do not contemplate Business Development Companies (BDCs) and their unique portfolios,” and, therefore, are “not specifically applicable to BDCs.” Allied believes that “SBA guidance is far more applicable to the portfolio of a BDC than the valuation guidance set forth by the SEC.” We have spoken with the SEC and confirmed BDCs should use SEC rather than SBA guidance.

We were surprised that Mr. Jenkins gave voice to a conspiracy theory without contacting us to comment or at least to check his facts: Greenlight has had no contact with any of the law firms that are suing Allied. Linking us to them based on the motivated comments of a defensive CEO without corroboration is irresponsible, in our view.

The next day, I wrote Walton and Sweeney. In the letter, I pointed out that I had refrained from personal attacks and said they were not practicing similar professional courtesy:

We understand that you may not appreciate us in our role as whistle blower. We do not understand why rather than addressing our issues in a professional manner, you have engaged in a pattern of false personal attacks for which you have no basis. According to press accounts you have engaged professional assistance in public relations in an effort to better attack us. Be advised that no matter how far into the mud you roll, we have no intention of joining you there.

At the end of the letter, I pointed out:

We have published our analysis and do not believe it contains any misinformation. We have listened to three conference calls and read several press releases from you designed to refute our criticisms and have yet to hear any factual errors in our research. Generally, your responses have been non-responsive, out of context or refutations of your mischaracterizations of our actual criticisms. However, if we have made any factual errors, we invite you to point out specifically where in our analysis we are factually mistaken. In the event any such errors exist, we will publicly correct the record.

Allied’s name-calling was part of its playbook to distract people from the real problems, and I did not expect it to retract or apologize. However, we had put out a lengthy analysis on our Web site, and I sincerely wanted to be sure we hadn’t made any errors. Sweeney responded about a week later in a brief letter that said we were wrong, as they showed in the conference calls. She wrote about my “false statements” and innuendos without identifying them. “Your attack on Allied Capital is inaccurate and irresponsible; you are no ‘whistle blower,’” Sweeney wrote.

When she declined to identify any actual errors, I took that as yet further confirmation of the soundness of our analysis. I would just have to put up with their attacking our criticisms as a “campaign of misinformation for personal profit,” which sounded like a cheesy slogan in a dirty Senate race. A few weeks later, Forbes published an article outlining some of our criticisms, and Allied’s response was to continue the personal attacks by denouncing me as a “predator” and declaring, “We’re not going to let [the] shorts get away with this.”

CHAPTER 12

Me or Your Lyin’ Eyes?

A few days later, on July 23, 2002, Allied announced its second-quarter earnings. We’ve seen a lot of examples in short sales where the company maintains that the short-sellers are wrong, but at the same time the company has to change either its accounting or business practices so that the results fail to live up to previous standards. This process began for Allied with this quarterly announcement.

Allied announced only forty-one cents per share of net investment income (this term excludes write-ups and write-downs of investments and is used interchangeably with operating earnings) compared to fifty-three cents per share the prior quarter and forty-six cents in the year-ago quarter. Analysts expected fifty-seven cents per share. Weeks before, Walton highlighted the importance of these “recurring earnings” from interest, fee, and dividend streams that excluded volatile gains and losses in the portfolio. Interest income was less than expected, because non-accrual loans more than doubled from $40 million in the March quarter to $89 million in the June quarter. PIK (payment-in-kind) income fell from $13 million in the first quarter to $8 million in the second quarter, and fee income fell from $16 million to $11 million.

Clearly, Allied adopted a more conservative revenue recognition policy. Because Allied recognized PIK income in a wide number of loans, there was no other explanation for the 40 percent sequential decline. Allied probably took a new, more conservative view of non-accruals, interest income and fees that caused the sudden shortfall. Allied also changed how it wrote-up and wrote-down investments. In previous periods, Allied made few adjustments to the investment values, but now adjusted a large number of investments. Allied wrote-down the “money good” investment in Startec’s operating company from $10.2 million to zero and did the same to the remaining $4.3 million investment in Velocita.

Allied