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) 📕

SBA considers it a default. BLX notifies the SBA and requests the SBA to satisfy the guarantee, which the SBA pays. BLX continues to try to collect and/or resolve the default for as long as it can, which can be years. Neither BLX nor the SBA count the loan as a “loss” until the loan resolution is complete. So BLX’s “losses” are “small” mostly because it doesn’t resolve defaulted loans in a timely fashion.

However, a benefit of publicly discussing Allied was hearing from others. Jim Brickman, a retired real estate developer from Dallas, introduced himself by e-mail. Someone had pointed him to Greenlight’s analysis because of his background in SBA lending. Brickman served on a creditor’s committee responsible for liquidating and evaluating the value of the SBA platform of Amresco, a Dallas-based lender that went bankrupt in 2001. With the assistance of Houlihan Lokey, a boutique investment banker, he sought to find a buyer. There was none at even a fraction of book value. So Brickman approached the BLX discussion with a clear understanding that SBA lending platforms are not worth sixty-five times earnings or five times book value, especially when the balance sheet has multiples of its book value in residual assets.

Recall that residuals are the estimated present value of future cash flows. The estimate depends on various assumptions. Historically, many companies have used assumptions that proved too optimistic, leading to future write-downs. As a result, investors take a skeptical view of residual asset values. Allied’s staunch refusal to provide the assumptions BLX used to estimate its residuals raised further doubts.

Brickman’s e-mail began a long dialogue. While I’ve spent more time on Allied than I can quantify, Brickman has spent much more; he is retired and his kids have grown. As he sees it, “These people believe they are above the law.” He has become an expert at searching public records, analyzing information, and has been a major collaborator in identifying problems at Allied and BLX. He is one of the best forensic detectives I have ever met. He finds the Allied story—how it has developed and persisted—as amazing, surprising and disheartening as I do.

His first big find involved two of Allied’s investments, GAC and Fairchild Industries, each of which filed for bankruptcy in early 2003. The bankruptcy documents indicated that Fairchild defaulted on $6 million of senior debt to Provident Bank in 2001 and stopped paying interest on Allied’s junior debt investment in January 2002. Despite this, Allied valued its debt investment in Fairchild at cost throughout 2002 and even carried its warrants at an unrealized gain. In December 2002, Allied wrote its warrants to zero. Even after Fairchild went bankrupt, Allied carried its loan at cost in March 2003. Finally, Allied began to write-down the loan in June 2003 (see Table 15.1). Ultimately, after Allied doubled its investment, Fairchild’s results improved and Allied exited with a gain in 2005.

Table 15.1 Fairchild Industries

Brickman’s work on GAC showed that it was another case of Allied ignoring reality. Remember that Sweeney taunted the short sellers about not doing their basic homework on GAC. Though it was Allied’s third largest investment at cost, Allied didn’t feel a need to disclose its bankruptcy via press release, in its earnings announcement or even in its 10-Q. Allied appeared to announce only good news. For example, around the time of GAC’s bankruptcy, Allied issued separate press releases announcing a $7 million gain on the disposition of CyberRep and an $8.4 million gain from selling Morton Grove Pharmaceuticals.

Bankruptcy documents showed that GAC had only $6 million of revenues and negative cash flow. Given what Off Wall Street reported about GAC, it is doubtful the business was ever profitable. Even as Sweeney had said the critics didn’t know what they were talking about, Allied wrote GAC down $5 million in June, $9 million in September, and $5 million in December 2002, leaving the value at $20 million. This was a good example of Allied taking gradual write-downs to smooth its results. Walton was asked about GAC on the first-quarter conference call. Without even acknowledging the bankruptcy, he indicated there had been management changes and he thought there was “an interesting business plan going forward.” We never learned just how interesting that business plan must have been.

The bankruptcy forecast indicated that GAC expected further declines in performance. Over time, the actual results came in worse than the forecast. By June 2005, Allied showed an unrealized loss of $50 million on its original $50 million investment. It had invested an additional $8 million during the bankruptcy, which it carried at $8 million. As part of its strategy of selling the winners and keeping the losers, Allied elected not to take a $50 million realized loss, which would have provided a valuable tax shield for shareholders—but would have reduced Allied’s taxable income, which supports the distribution. Instead, Allied changed the name of the company to Triview Investments Inc. and infused another $78 million to make acquisitions in an unrelated field, taking an additional $15 million write-down. This was an example of Allied’s sacrificing economics for improved optics (see Table 15.2).

Table 15.2 Galaxy American Communications

Allied also had an investment in, and had a representative on the board of, Redox Brands, a consumer cleaning-products company. Todd Wichmann, a former CEO of Redox, called in early 2003 to tell us Redox violated its bank covenants and obtained a waiver and an additional investment from Allied in the second quarter of 2002. Though Allied added $7 million to protect a $10 million investment under duress, it did not write-down the initial investment. The very next quarter, Redox appeared likely to violate the revised covenants. Wichmann told us that Allied put pressure on management to falsify the financial statements to hide the default from the bank. Wichmann said management refused to go along, but carefully documented Allied’s inappropriate request.

He told us on the phone, “Things were requested of me as CEO that I resisted vehemently and I documented this to