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) 📕

Allied’s 2003 10-K indicated it held a debt investment of $27.3 million, while Garden Ridge’s financial statements reflected only a $25.3 million obligation. We suspected Allied might have recognized an extra $2 million of PIK income that didn’t even appear on Garden Ridge’s books. Garden Ridge’s bankruptcy records indicate that, from 1999 to 2002, comparable store sales fell by 16 percent, and earnings before interest, taxes, depreciation, and amortization (EBITDA) fell from $24.8 million to −$18.3 million. From the time Allied invested—after which its deterioration shortly began—Garden Ridge lost about $45 million. Nonetheless, Allied carried all of its debt and equity investment in Garden Ridge at cost through September 2002. In December 2002, it belatedly wrote down the equity to zero and the debt to 95 percent of cost. Allied took incremental modest write-downs nearly every quarter through the end of 2004 (see Table 21.3 on page 198).

Table 21.3 Garden Ridge

A few months earlier, around the turn of the year to 2004, I had discussed our Allied investment and the government’s lack of responsiveness with one of our long-time partners. She was aghast at the story and said she knew SEC Chairman Bill Donaldson socially. She offered to pass our information directly to him. I wrote her a two-page summary, to which she attached a personal note. A couple of weeks later, she received a form letter thanking her for her letter. A couple weeks after that, four SEC enforcement officials called her to find out if she had more information on Allied. Apparently, the SEC finally formed a team to investigate our concerns. Now, I was the one aghast that this is what it took to get the SEC off the dime.

Brickman wrote to the SEC about the $9 million loan transfer. The SEC called Brickman and invited him to Washington for a meeting to discuss it. Brickman asked the SEC if I could join him. We scheduled the meeting for April 27, 2004.

Brickman also called Houck, the analyst at Wachovia. Houck initiated coverage of Allied with a “Strong Buy” at $23.20 per share two days after my speech and aggressively argued his bullish view with me. But since then, he repeatedly lowered his opinion of the company. He cut his rating to “Buy” in July 2002 at $22.40 per share after Allied announced the disappointing second-quarter results. In January 2003, he lowered the rating to “Market Perform” at $23.55 per share citing “valuation considerations.” Finally, he lowered his view to “Underperform” in April 2003 at $21.22 “due to increased dependency on capital gains to support the current dividend, anticipation of two consecutive years of declining NOI/share (Net Operating Income), increased risk of a dividend cut in 2004, continued deterioration in credit quality metrics, and valuation considerations.”

Houck lobbied Allied to provide better disclosure, including the secret gain-on-sale assumptions at BLX. When they refused, he wrote, “Given the relative size of BLX, we believe management should provide audited financial statements for BLX.” Houck completed a transition from optimistic to pessimistic about the company and published several critical research notes. In October 2003 he wrote, “We continue to struggle with Allied’s disclosure and lack of transparency with respect to their private finance portfolio. In our opinion, it is difficult to assess the reasonableness of the management’s portfolio company valuations . . .”

He also challenged the valuation of BLX. He said: “We have specific concerns regarding the valuation of BLX. Without disclosures on BLX, it is difficult to assess the appropriateness of management’s valuation of the portfolio company. Specifically, in order for investors to gain comfort with valuations, they need to be able to compare the original assumptions used to calculate gain-on-sale at the time of BLX’s securitizations versus the actual experience (e.g., loss rates, prepayments, discount rates). An increase (decrease) in loss rates or prepayment speeds versus original assumptions can result in a decrease (increase) in the carrying value of the residual asset that is created at the time of securitization. For companies that securitize loans on a regular basis, industry standard is to report monthly loss and prepayment experience on a static pool basis (i.e., AmeriCredit, Capital One, Providian). In the case of BLX, Allied reports aggregate data only on a quarterly basis, and the data is limited in its utility because growth and acquisitions can mask the underlying trends. In addition, we also believe that in Q2 2003, Allied changed the composition of the peer group used to value BLX, which, in our opinion, further obfuscates the valuation of BLX. On its Q2 earnings conference call, Allied management noted that the peer group for BLX had changed but declined to discuss the composition of the peer group at that time. Management indicated that the peer group used to value BLX would be identified in the subsequent 10-Q filing. However, the composition of the peer group for BLX was not identified in the 10-Q.”

Brickman informed Houck about the dubious $9 million loan transfer. Houck called Allied, which informed him that it was just one bad loan. Houck relayed this to Brickman, who indicated that it was ten bad loans. Houck went back to Allied. Allied said it fully disclosed the transaction in its SEC filings.

In Allied’s SEC disclosures, under a footnote titled, “Supplemental Disclosure of Cash Flow Information,” Allied wrote, “Non-cash operating activities . . . included . . . receipt of commercial mortgage loans in satisfaction of private finance loans and debt securities of $9.1 million.” Calling these loans, which had defaulted and, in some cases, been discharged, “commercial mortgage loans” was quite a stretch. Though the transaction occurred in February 2003, Allied did not refer to this deal in the March 31, 2003, 10-Q. Instead, it made its first reference in the June 30, 2003, 10-Q, which identified a $9.9 million transaction. Allied amended the amount to $9.1 million, which matched the repurchase agreement, in its subsequent filings. Though the June 30, 2003, 10-Q had pages of disclosure about BLX and, in fact, references