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) 📕

Distributions are much more predictable and manageable than earnings. Distributions are declared at the discretion of the board and limited only by the company’s ability to fund them. Taxable income is managed and maximized by selling winners and keeping losers and Allied has significant control over which investments it exits.

In May, Sweeney had said, “What we do think is important to our valuation as a public company is our net income, which communicates our earnings power to shareholders.” Now, just two months later, Allied wanted everyone to ignore that and concentrate solely on easily manipulated “taxable earnings” and its distributions.

Allied let me through to ask a question on the second-quarter earnings conference call. Perhaps my complaints that I had been screened got back to them. I questioned Allied’s new enterprise value valuation technique, and referenced In Re Parnassus, a case where the SEC ruled that investment companies should value the actual securities they own, as opposed to the value that could be achieved in the sale of the entire company when there were no bids pending. Sweeney gave a lengthy speech, indicating that the value of a company is linked to the value of its securities and how Allied interacts with other co-investors. She did not answer my question. Walton chimed in, pointing out that liquidity events happen when the company is sold, and that they had no plans to sell the securities.

I pointed out that the SEC current-sale test is based on the securities they actually own as opposed to the whole enterprise. I described how debt securities fall in value if the equity cushion erodes. I observed that under their standard, they would carry the debt at the same value regardless of whether it was supported by a fat equity cushion or an extremely thin one. Sweeney replied, “I think that you end up with the identical result,” and proceeded to talk about how equity values rise and fall in the same way that enterprise values rise and fall. I pressed that I was talking about debt instruments, not equity instruments. Sweeney responded by stating the obvious, saying that this is why there is equity beneath the debt, so it is the equity that suffers first.

Finally, Walton effectively ended the discussion, “David, we really have written and talked about this extensively. I would love if you wanted to give us a call to chat about it. We would be delighted to talk with you about it, but I think right now people want to learn a little bit more about our company.”

CHAPTER 13

Debates and Manipulations

Following the disappointing second-quarter earnings, Allied’s stock fell to $16.90 a share on July 24, 2002. The stock has never traded below that since. I sent a second, fifteen-page update to the SEC on July 31, 2002. I discussed Allied’s aggressive comments in its white paper and compared it to the annual report, demonstrating that Allied incorrectly followed SBA, rather than SEC accounting. I described Allied’s accounting transition to the enterprise valuation method and explained why it still was not SEC compliant. I dissected Allied’s unreasonable write-up of BLX and discussed the inflated interest rates Allied charged BLX and Hillman. I noted Allied’s false statements that its accounting was “consistent” when it was not.

To the extent the revaluations reflected changes in value that should have been made earlier, I asked the SEC to force Allied to restate results to reflect when gains and losses actually occurred and explain publicly how it changed its accounting.

I questioned whether Allied matched gains with losses to hold income steady. For example, write-downs increased from $15 million in the first quarter of 2002 to $80 million in the second quarter. Write-ups increased from $14 million to $99 million at the same time. Was this a coincidence—or had Allied either created write-ups to match the write-downs or limited the amount of write-downs to the amount of write-ups it could find? Finally, I enclosed a copy of the BancLab analysis and discussed what the former BLX employee told me without identifying him.

I figured when the SEC followed up on my letter, it would call to get his contact information. Yet, no one from the agency contacted us. I was disappointed by the lack of interest and diligence.

Allied announced it would have an investor day in early August. The event would last for several hours and give us a chance to ask questions in person. James Lin and I flew to Washington to participate. It was a noncombative meeting that covered little new ground. Allied paraded on stage a large number of senior officers demonstrating a deep, experienced team. The group appeared quite presentable.

Many people think you can spot crooks by their appearance. The stereotypical crook looks like a mobster, flaunts gaudy jewelry, or sports an all-season tan. The Allied team had none of this. They were well dressed and well spoken, sounded earnest, and seemed like nice people. In fact, they were quite charismatic.

Some of my favorite movies, including The Sting and Dirty Rotten Scoundrels, feature well-spoken, attractive, confidence men and women. Perhaps the same can be said for some of the CEOs behind real-life scandals I had experienced, including Gary Wendt (Conseco), Al Dunlap (Sunbeam), and Donal Geaney (Elan), not to mention Bernie Ebbers (WorldCom) and Ken Lay (Enron).

Instead of arguing with its critics, the company played to its core audience. It was as if Allied modified P. T. Barnum, as illustrated in Mike Shapiro’s cartoon (see Figure 13.1), “Remember, you can fool some of the people all of the time. Those are the people we need to concentrate on.” Allied was much more positive, even friendly. There was hardly any mention of the issues that concerned us.

Figure 13.1 Cartoon

However, Allied was plainly scared of uncontrolled questions and answers. Most investor days allow a lot of time for Q&A. Here, Allied budgeted only a half hour and pointedly