David Einhorn: "Our Results Have Been Far Worse Than We Could Have Imagined" - Full Q2 Letter

One month ago, in our ongoing chronicle of the pain suffered by David Einhorn's Greenlight Capital, we reported that based on interim monthly numbers, the fund had lost a massive 8% in the month of June, bringing his - and his LPs' - total loss for the year to 19%. The reason: Einhorn got clobbered on both side of his portfolio, with his 20 biggest long positions falling sharply, while his 20 largest shorts - most of which are the prominent growth and tech names that have been beaten down recently - surged.

Today, in his just released Q2 letter to investors, Einhorn not only confirms the poor performance, but also notes that "over the past three years, our results have been far worse than we could have imagined" and while hoping he will be vindicated in the end, he admits that "Right now the market is telling us we are wrong, wrong, wrong about nearly everything. And yet, looking forward from today we think this portfolio makes a lot of sense."

Will readers, and more importantly, his LPs agree, or will they decide to pull their capital from the hedge fund? That remains to be seen.

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Below are key excerpts from the letter:

Dear Partner:

We had another difficult quarter and lost an additional (5.4)%,1 bringing the Greenlight Capital funds’ (the “Partnerships”) year-to-date loss to (18.3)%. During the quarter, the S&P 500 index returned 3.4%, bringing its year-to-date return to 2.6%.

Over the past three years, our results have been far worse than we could have imagined, and it’s been a bull market to boot. Yes, we have made some obvious mistakes – the worst of which was not assessing that SunEdison was a fraud in 2015 – but there have been others. A number of years ago one of our investors said Amazon would surpass Apple and become the most valuable company in the world. We didn’t get it then and, truthfully, we don’t really get it now. But, there is a reasonable possibility that he will be proven right.

Some have looked for reasons other than isolated mistakes. Theories include getting older, changing lifestyles, and an unwillingness to adapt to new market environments. We have been accused of being stubborn, but one person’s stubbornness is another person’s discipline. We will continue to be disciplined. Although it might be nice to have something to blame for the poor results, the truth is that we have been making every effort and leading with our best thinking.

Even if it isn’t the whole explanation, the environment for value investing has been tough. AllianceBernstein recently reported that value investing strategies are performing in the bottom one percentile since 1990. In just the past 18 months, the Russell 1000 Pure Growth index has outperformed the Russell 1000 Pure Value index by 54%. The reality is that the market is cyclical and given the extreme anomaly, reversion to the mean should happen sooner rather than later. We just can’t say when.

Our friend Vitaliy Katsenelson once wrote an essay about value investing that articulates what the past three years have felt like better than we can. He wrote:

Investing is a nonlinear endeavor that is full of ups and downs. Every investor will have periods when his or her strategy is completely out of sync with the market. When the market is roaring on its way up and your portfolio is down, you may be sure that pain will rear its ugly face.

Value investing is almost by definition a contrarian endeavor. Growth investors ride the train of love, harmony, peace, and consensus – they buy companies that Mr. Market is infatuated with and thus prices them for love. (But just so you know, love ain’t cheap and rarely lasts forever, at least when it comes to growth stocks.)

Value investors, on the other hand, live in the domain of hate – they buy what others don’t want. Ironically, value investors may end up owning the same companies that growth investors used to own. When the love is gone, hate goes  on a rampage; and trust me, you won’t find anyone who’ll pay extra for hate. It is cheap.

Investment styles go through cycles. Sometimes your stocks are really out of favor. Nothing you do works. You keep telling yourself that in the short run there is little or no link between decisions and outcomes. That’s a truism of investing, and even you believe it on an intellectual level. But every day you come to work and the market tells you you are wrong, you are wrong, you are wrong.

Right now the market is telling us we are wrong, wrong, wrong about nearly everything. And yet, looking forward from today we think this portfolio makes a lot of sense.

One of our general goals is never to be your biggest problem. Unfortunately, we have been lately, and a good number of our partners have had enough and redeemed. We appreciate you for sticking with us through this challenging period. We certainly understand those who have run out of patience as this period has lasted longer than we could have envisioned. Maximizing the size of our capital base has never been our goal; maximizing returns is and always has been. In our history, we have raised ~$6 billion, and paid out ~$8 billion to investors.

Bad results aren’t fun, but we are determined to show up to work every day to engage in solving the puzzles in the market, as we always have. It remains exciting when we think we have figured something out – which doesn’t happen every day or even every week, but historically has been lucrative when we do.

Amid some other disclosures, we found the following commentary on Tesla amusing:

Speaking of TSLA, by all available evidence, the company has had a difficult year. TSLA has had trouble demonstrating efficient production, and it has delayed capital spending which pushes out future growth opportunities in the Model Y and the Semi. TSLA is accommodating Model 3 customers who are willing to pay for premium features – making the car more of a luxury item with a smaller addressable market than the mass market car TSLA had promised. This high-grading of the backlog combined with the reduction in the government subsidy by early next year, new product delays and the emergence of viable competition for the Models S and X means that 2019 should be a very challenging year for TSLA. We doubt the entry-level Model 3 will be produced profitably anytime soon, if ever.

The odd thing is that while investors claim to be interested in the long-term growth of TSLA (as the valuation certainly can’t be supported by the current loss-making enterprise), the company is focusing investors on very short-term goals. Can the company produce a certain number of cars in a single week through short-term surge production techniques? Can the company fire enough staff and scrimp on capex to show a profitable or cash flow positive quarter or two?

On the other hand, we wonder whether surge production techniques to support self-congratulatory tweets are economically efficient ways of ramping production, or whether customers will be happy with the quality of a car rushed through production to prove a point to short sellers. We also wonder whether the company’s lack of capital and its  determination to show positive cash flow is delaying investments in additional manufacturing capacity and infrastructure necessary to fulfill the bulls’ long-term growth expectations. With TSLA’s first-to-market window beginning to close, delaying investment undermines the opportunity. Strangely, the bulls don’t seem to care.

On a personal note, David is happy that his Model S lease ended (there were growing problems with the touchscreen and the power windows) and is excited to get the Jaguar IPACE, which has gotten excellent reviews. The Model S residual values are falling. Meanwhile, the Model 3 initially received lukewarm reviews, and the raft of bad publicity is probably having a negative impact on the brand.

The most striking feature of the quarter is that Elon Musk appears erratic and desperate. During the quarter Mr. Musk:

  • Attacked an analyst for asking “boring bonehead questions” on the quarterly conference call;
  • Hung up on the head of the National Transportation Safety Board;
  • Assailed the media for the audacity to report that Tesla’s customers crash while using “autopilot”;
  • Accused an internal whistleblower of “sabotage”;
  • Appeared to paint the tape with trivial insider purchases; and
  • Went on a tweetstorm calling for “the short burn of the century.”

The market preferred this bravado much more than say, GM’s actual accomplishments. TSLA soared 29% during the quarter and was our second biggest loser.

Some other highlights:

  • Greenlight used the recent spike in AthenaHealth shares to re-short some shares that the firm covered previously. Believe that activist (Elliott offered to pay $160/share) has little interest in actually buying ATHN
  • Greenlight made a new investment in Altice Europe
  • Covered Dillard’s long after 3 years with a small loss; business deteriorated faster than expected
  • Covered 5-year old short in Elekta AB with small gain
  • Exited Resona Holdings long with medium profit

At quarter-end, Greenlight's largest disclosed long positions in the Partnerships were Bayer, Brighthouse Financial, CNX Resources, General Motors, and gold. The Partnerships had an average exposure of 96% long and 75% short.

Full letter below: