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) 📕

We had no role in the recommendation. I only had a single, brief conversation with Alpert several months earlier. I had no idea whether he agreed with us or not and had no indication he would begin to cover Allied. The Exchange’s investigation ended without action.

As Alpert put it, “It’s ironic, especially in today’s world of research, that the NYSE would investigate a sell recommendation. What better way to intimidate independent thought? It was clear from the beginning that I had been accused of accepting compensation from short seller(s). I assume Allied was behind the allegation.”

According to Greenlight’s Deutsche Bank salesman, Allied was quite upset and wanted the “Sell” recommendation removed. At the end of the year, Allied got its wish when Alpert left and the bank ceased to cover Allied. A few months later, Allied let Deutsche Bank—which, at that point, no longer even had an analyst covering the stock and had never underwritten an offering for Allied—underwrite the first of at least five stock offerings, for which the bank made millions of dollars in fees.

CHAPTER 15

BLX Is Worth What, Exactly?

The equity and high-yield bond markets plummeted in the third quarter of 2002, following the WorldCom fraud. Allied announced its quarterly results, which were only a few cents below analysts’ estimates. Operating income actually improved, led by a pick-up in PIK income. Allied again had a large number of write-ups and write-downs during the quarter—ending in a wash. Most notably, Allied held its investment in BLX constant. It was hard to imagine how Allied justified this, since the stock prices of BLX’s three publicly traded comparable companies Allied used for valuation purposes fell an average of 32 percent during the quarter.

During the earnings conference call on October 22, 2002, Allied discussed accruing income from controlled companies. According to Sweeney, “What we don’t want to do is accrue interest income if we’re continuing to fund them on a routine basis because we look at that as if we are accelerating interest income that we are funding. So we don’t do that.” On that basis, how could they recognize income from BLX? Allied’s SEC filings revealed BLX burned cash and needed ongoing capital for its operations. Allied routinely contributed that capital, either directly through fresh investment or indirectly by guaranteeing bank loans.

At the end of the conference call, Walton gave tax distribution guidance. The company estimated distributions of $2.20 a share in 2002, followed by 5 percent growth in 2003. The company’s previous target had been a 10 percent annual increase. Management explained on the conference call that 10 percent had been more of a long-term goal. The company further said net investment income would be 80 percent of the 2002 distribution and 85 percent of the 2003 distribution. This implied net investment income in 2003 of $1.95 a share. When the dust settled on 2003, net investment income was only $1.65. Allied filled in the gap with additional capital gains. By then, Allied managed to convince its shareholders money was money and the distribution was the distribution no matter how it was funded. In fact, Allied came to argue that net capital gains are actually better than net investment income because they are taxed to the investor at a lower rate. In May, Walton had pushed the opposite (more conventional) view: Net investment income is superior to capital gains because it is more predictable.

Allied defended its treatment of BLX with additional misleading comments. When questioned about the $100 million of residuals on BLX’s balance sheet at the Bank of America investor conference in September 2002, Sweeney told the audience, “I’d buy a $400 million stream of cash flows for $100 million.” This answer created the misimpression that BLX’s residuals had hidden value. However, embedded in the $400 million figure was the absurd assumption that no loan ever defaulted or prepaid. Allied had no interest in allowing investors to judge the value for themselves by sharing the actual prepayment and default assumptions or history. Further, Sweeney told investors at a Piper Jaffray conference in November 2002 that BLX’s SBA loans “perform in line with the national average.”

I provided reporters from both The New York Times and The Wall Street Journal with the BancLab analysis, access to the former BLX executive who had contacted us, and described Allied’s inflated valuation of BLX. I knew Jesse Eisinger from the Journal had visited Allied. As time passed without an article—his initial period for an exclusive had long since passed—I came to believe there wouldn’t be one, so I decided to write the story myself. Several months earlier, TheStreet.com, a financial news Web site, invited me to become a contributor. I took them up on the offer and wrote a two-part article titled, “The Joker in Allied Capital’s House of Cards,” which the site published on December 10 and 11, 2002. The story highlighted the problems with gain-on-sale accounting, BLX’s loan performance, questioned the nonconsolidation of BLX and recounted the absurdity of Allied’s BLX valuation. At the same time, we added the BancLab analysis to our Web site.

There was no measurable reaction to the story anywhere. None of the brokerage firm analysts commented on any aspect of the issue. When the stock, which traded at about $22 per share at the time, did not react, Allied’s management probably thought no immediate response was necessary. On the conference call discussing fourth-quarter results held two months later, Roll responded, “We are aware of what we believe to be an inaccurate report in the market regarding BLX and its 7(a) loan portfolio quality.” Again, she didn’t specify any inaccuracies, but said that according to BLX’s own data, the losses on the unguaranteed pieces over the last five years averaged less than 1 percent and the performance was better than the national average.

Roughly two years later, I learned the difference between the BancLab data, which showed defaults, and Allied’s description of “losses.” When loans become 60 days late, the