Fooling Some of the People All of the Time, a Long Short (And Now Complete) Story, Updated With New David Einhorn (best classic books of all time .TXT) 📖

charged a fee. When the reinsurers saw what happened, several refused to pay claims. Almost every workers’ compensation insurance stock collapsed as the scheme unwound. I suspect the favorable reinsurance Unicover offered enabled SHSE to change its business model. Unicover’s exposure probably would have caused SHSE to implode along with the other workers’ compensation companies. However, any problem belonged to Liberty Mutual rather than us. Sometimes it is better to be lucky than smart.

Another short that did well was Century Business Services (CBIZ), a “rollup” of accounting service firms with lousy accounting itself. In a rollup, a consolidator buys small, private companies at a lower multiple than the consolidator receives in the public markets. Every acquisition is accretive to earnings, which drives the stock price higher and enables the consolidator to use its currency to do more acquisitions of private companies in a never-ending virtuous cycle. Michael DeGroote, a famous and wealthy former partner of H. Wayne Huizenga of Blockbuster fame, led CBIZ. Like most roll-ups, CBIZ claimed to improve the operations of the acquired companies and generate 15 percent internal annual revenue growth. In fact, the sellers tended to be entrepreneurs toward the end of their careers. They sold their businesses to CBIZ and hit the golf course.

CBIZ’s accounting was not compliant with generally accepted accounting principles (GAAP) in several ways. First, CBIZ recognized revenue on newly acquired firms starting on the “effective” acquisition date, which occurred before they actually closed the deals. Second, CBIZ valued the stock it issued as currency at a 40 percent discount to the market value. These tricks enabled it to recognize revenue prematurely, understate goodwill, and mislead investors about the multiples it paid for acquired companies.

For the first time in Greenlight’s history, we wrote letters to the SEC. We critiqued CBIZ’s accounting and asked the SEC to insist on clearer disclosures in future filings. The SEC never responded to us. However, a year later CBIZ restated its acquisition accounting to use “closing” dates rather than “effective” dates to begin recognizing revenue and to increase its goodwill. It reduced the “internal” growth rate, missed budget by a wide margin, and replaced the management team. The shares collapsed from $25 in August 1998 to less than a dollar each in October 2000.

But because we covered CLCX and Sirrom just before the market began a rapid descent into the Russia default, Long-Term Capital Management, and Asian economic crises, we had greater-than-usual net long exposure at the wrong time. As a result, we lost money for five consecutive months, from May to September 1998.

August was our worst month ever. The market had a huge sell-off at the end of the month. I was on vacation in upstate New York that week. The prices were crazy, and there was nothing to do about it. We couldn’t look at the screen and say these were “fire sale” prices generated by other investors going through “forced liquidations.” As detailed later, these were the type of excuses Allied would use to hold its impaired investments at inflated values. The price was the price, and we marked the portfolio to reflect that. We lost more than 8 percent that month. Ouch.

One of our largest partners was a semi-retired, well-known hedge fund manager with a fine, lengthy track record. We were proud to have him as a partner. As the story goes, he claims he called our office on that last day of August and no one returned his call. Keswin, who was not on vacation, said it was absolutely impossible that he would have ignored this partner or his call. The partner soon summoned us to his office. He said he could not believe how irresponsible he thought we had been. He asked about our portfolio. We described our largest investment in Agribrands, an animal feed manufacturer that had been spun off from Ralston Purina. With its Asian market exposure, it had fallen in the sell-off that summer. It was still a great opportunity and would be an enormous winner in 1999. Ultimately, Cargill bought the company a couple of years later for twice where it traded in late 1998. As we told the story, this semi-famous investor scoffed. “I thought you were moneymakers!” At his first opportunity, he fully redeemed his investment in Greenlight. For the next five years, every few months someone told me they’d met him and heard how lousy we were.

He was not alone. A good number of our partners reconsidered their investments after our bad five-month run. While we had worked hard to explain our program and the related risks, some of our partners probably paid more attention to the short-term track record. Our partners redeemed about half their accounts between August and January. It would have been worse except our portfolio of depressed securities recovered with the market in the fourth quarter. Some partners maintained confidence and even increased their investments, and we attracted some new partners. Overall, new investments matched redemptions. We finished the year up 10 percent and ended with $165 million under management.

Though we generated attractive risk-adjusted returns in 1998, we didn’t hit our goal. Growth stocks and large-capitalization companies were the flavor of the day. Many of the huge stocks leading this advance would take years to grow into the nosebleed valuations they achieved that year. The S&P 500 shrugged off the Asian crisis to return an eye-popping 28.3 percent. Coca-Cola led the market, trading around fifty times earnings. The earnings were low quality because the company divested its bottling operations one at a time, creating gains that counted in the earnings. I did not have the guts to short Coca-Cola, but I should have. I figured with a company that large I couldn’t possibly have a unique insight. Instead, I contented myself with explaining Coca-Cola’s problems in investor meetings and quizzing prospective hires about their views on the subject.

CHAPTER 4

Value Investing through the Internet Bubble

From the 1998 low, the Internet bubble launched to its full glory. I believe the battle