Greenlight Re (GLRE): Poor man’s Berkshire or interesting bet on a David Einhorn Comeback ?
Greenlight Re is an interesting special situation in my opinion combining 2 bets in one stock:
1. It is a bet that David Einhorn will come back after his worst year ever and 4 years of underperformance
2. Greenlight Re, the Reinsurance company whose investments he manages “mean reverts” at least closer to its historical price book ratio.
This “bet” should be relatively uncorrelated to the overall market and due to the construction of the investment mandate, Einhorn can charge only half of the performance fee for some time.
Disclaimer: This is not investment advise. DO YOUR OWN RESEARCH !!!
“Put your money to where your mouth is” is something I do preach indirectly since I started the blog 5 years ago. In my 5th anniversary post last week I said the following with regard to David Einhorn:
As I have said many times, I do think Einhorn is one of the very good HF investors. He really had a hard year. If I would be responsible for allocating money to hedge funds, I would actually increase my investment as good managers very often come back strongly after a bad streak.
As a private investor, I don’t think that I would be able to invest in one of his funds. But then I remembered that there is a possibility to do so even for “small guys” like me:
Greenlight Re is a Cayman based, US listed Reinsurance company with one specialty: The investment portfolio is managed by DME advisors which is basically David Einhorn and he is Chairman of the company.
The idea behind it is relatively easy: It is some kind of “Berkshire light” company. You have equity capital plus reinsurance. The reinsurance creates “float” which allows the company to leverage Einhorn’s investment results by a certain amount. Ideally, the leverage doesn’t cost anything but could even add to the overall result if the do good underwriting.
So far the theory. If we look at Greenlight’s stock chart since its IPO in 2007, we can see that the strategy didn’t work that well, at least compared to the chart of the “real Berkshire”. Actually the stock price is now lower than the 19 USD IPO price back in 2007:
The drop in the current year clearly has to do with Einhorn having a horrible year. Interestingly, Greenlight Re discloses Einhorn’s Performance on a quarterly basis back to 2004. -20,2% for 11 months in 2015 is clearly a disaster.
Digging deeper: Insurance vs. Investments & structural value creation
In order to assess if Greenlight Re is a proxy for Einhorn’s performance, we need to check if the “structure” is value creating or not. “Value creating” means that the Greenlight Re shareholder actually gets at least the same return (Return on equity) as the return on the investments.
There is a simple way to do this: Greenlight Re reports Einhorn’s performance as well as the investment result separately. We can therefore pretty easily compare the investment result with the overall result in the table below:
|vs. Stated perf,||2,05%||-4,52%||8,12%||3,03%||-1,33%||-5,38%||3,61%||0,75%|
This table does 2 things: It calculates the “leakage”, which is the overall result of the company minus the investment results. A positive result means they made extra money with the insurance business, a negative result means they lost money and had to “pay” for the float. In total, the “leakage” was around 76 mn USD or around 9,5 mn USD per year. So clearly the “float” and the structure do not come for free.
The “leverage” shows how much better or worse the actual ROE was compared to the underlying performance of the investment portfolio. In the beginning, this was around 1,25-1,3 but declined. In years with low returns the “leakage” of course has a bigger impact and in years with negative performance the leverage via the float of course works the other way.
Now we can calculate in a second step the compounded effect of leverage and leakage and see if the overall structure adds value or destroys value. Those are the results for 2007-2014:
So the good news is: The Return for shareholders is slightly better than the underlying investment return but not by much. So the leverage of the structure adds a little bit to Einhorn’s underlying returns.
How does this compare to S&P and the “real” Berkshire ?
This is a table comparing the stated ROE of Berkshire in the 2014 annual report and the S&P 500 against Greenlight:
So it is easy to see that the “real” Berkshire was better than Greenlight Re, but the still did beat the S&P 500 by a good margin. One has to take into account, that Einhorn charges “1,5% plus 20%” on his services. Without those fees, Greenlight’s performance would have been most likely pretty much similar to Berkshire.
2015: Annus Horiblis
If we look at at Einhorn’s relative track record to the S&P 500, we can see that the last 4 years were tough for him, but 2015 is clearly the worst ever:
Being -20% behind the benchmark is really tough, even for a start manager like Einhorn. The reasons are quite obvious: He runs a relative “market neutral” strategy at the moment. His longs (Sunedison, Consol) are not doing well and being short was no fun over the past few years.
According to Bloomberg, his biggest long positions are:
|Security||Ticker||Source||Position||Pos Chg||% Out||Mkt Val|
|APPLE INC||AAPL US||13F||11,227,274||+3.84MLN||.20||1.19BLN|
|GENERAL MOTORS CO||GM US||13F||16,298,818||+1.65MLN||1.05||548.78MLN|
|ISS A/S||ISS DC||EXCH||9,262,706||0||4.99||325.49MLN|
|AERCAP HOLDINGS NV||AER US||13F||7,344,500||+1.76MLN||3.72||294.81MLN|
|CHICAGO BRIDGE & IRON CO N||CBI US||13F||7,481,471||+758,014||7.13||287.59MLN|
|MICHAEL KORS HOLDINGS LTD||KORS US||13F||7,043,700||+3.42MLN||3.83||279.63MLN|
|TIME WARNER INC||TWX US||13F||3,814,700||+36,300||.48||242.27MLN|
|CONSOL ENERGY INC||CNX US||Form 4||29,609,565||0||12.93||218.52MLN|
|GREEN BRICK PARTNERS INC||GRBK US||13F||24,118,668||0||49.41||179.44MLN|
|MICRON TECHNOLOGY INC||MU US||13F||12,371,980||-25.58MLN||1.20||177.66MLN|
|ON SEMICONDUCTOR CORP||ON US||13F||17,305,600||0||4.19||173.23MLN|
|BANK OF NEW YORK MELLON CO||BK US||13F||4,000,000||0||.37||160.88MLN|
|TAKE-TWO INTERACTIVE SOFTW||TTWO US||13F||4,158,306||0||4.91||144.54MLN|
|VOYA FINANCIAL INC||VOYA US||13F||3,649,381||-2.23MLN||1.69||131.52MLN|
|SUNEDISON INC||SUNE US||13F||18,605,373||-6.24MLN||5.87||121.12MLN|
The portfolio is clearly a pretty “contrarian” portfolio, no “FANG” stocks to be found. I wouldn’t invest in most of them, but on the other hand that says nothing if they are going to be good investments.
Double hit for shareholders: Insurance losses
For Greenlight capital shareholders there is even a double hit in 2015: Looking at the Q3 report we can see that in the first 9 months, the overall result at -283 mn USD loss is even -47 mn lower than the -236 mn USD investment loss.
So the insurance side added a big loss at the same time that the investment result was really really bad. That had clearly an impact on how investors value Greenlight. This is the “end of period” Price/Book valuation for Greenlight Re since IPO:
|P/B Ratio adj. B Shares||1,48||1,15||1,46||1,47||1,29||1,23||1,42||1,25||0,93|
For some reason, the official Bloomberg ratios do not include the class B shares held by David Einhorn, so I adjusted them accordingly.
We can see clearly that in the past, investors valued Greenlight at around 1,2 -1,4 times book value. Following the incredibly bad 2015, the stock now trades below book value.
A quick look at the Insurance side:
What Greenlight does in its Insurance area can be best described as “commodity business”. I don’t think that they have any competitive advantage.
Greenlight is doing around 60% Liability insurance. Liability insurance is one of the most dangerous business lines in Property and Casualty (P&C) because it can take very long time until the claims materialize. Take car insurance for instance. If claims go up to much, you see it directly, with liability insurance you often see claims occurring many years later. If done smartly and cautiously, liability insurance can be quite interesting, because due to the long time horizon’s it creates float. In Greenlight’s case however they seem to have underwritten some bad contracts. Overall, I would not attach any significant value to the iInsurance business.
One positive observation: It seems that they do underwrite now more opportunistically which is good. Premium income declined significantly from 2013 to 2014. Reducing premium when prices are down (as they are now) is a good sign that they might have learned a lesson or two.
The “kicker”: Investment management fee agreement
This is the relevant section from the annual report:
Pursuant to the venture agreement and the advisory agreement, DME Advisors has the exclusive right to manage substantially all of our investable assets, subject to the investment guidelines adopted by the respective Boards of Directors of Greenlight Re and GRIL, for so long as the venture agreement is in effect. DME Advisors receives a monthly management fee based on an annual rate of 1.5% of the capital account balance of each participant. In addition, DME receives a performance allocation based on the positive performance change in such participant’s capital account equal to 20% of net profits calculated per annum, subject to a loss carry forward provision.
The loss carry forward provision allows DME to earn a reduced performance allocation of 10% on profits in any year subsequent to the year in which a participant’s capital account (other than DME) incurs a loss, until all the losses are recouped and an additional amount equal to 150% of the loss is earned. DME is not entitled to a performance allocation in a year in which the investment portfolio incurs a loss.
This fee structure is interesting especially after such a down year as 2015. If we assume that Einhorn finsihes -20% for 2015, he needs to earn first the -20% back and then 30% more until his old 20% carry kicks in. So for the next 50% or so he “only” can charge 10% performance premium instead of 20%. Although this is still no super bargain, it does increase the “come back” bet further as Greenlight Re shareholders will have a better upside profile than compared to the last 8 years. All other things equal, Greenlight should actually trade at higher comparable valuations than the years before because the upside is better for shareholders than in the past.
Investment case / Valuation
My investment case is quite simple. The upside case includes the following components
a) Einhorn gets his Mojo back and outperforms (10-30%) over 2-3 years
b) the upside participation for GRLE shareholders is better than in the past as the performance fee will be 10% instead of 20% for some time (+1-3%)
c) Greenlight Re at some point in time trades back to 1,2 times book value (30% upside)
d) Maybe even the Insurance part makes some profits (not included)
So overall I think the stock could earn me between 40-65% over the next 2-3 years.
I think the “Einhorn recovery” stand-alone would not be enough, but that the mean-reversion potential makes the stock interesting. However the “mean reversion” clearly is directly corellated to the outperformance. Without any outperformance, the current valuation around book value is clearly a realistic level.
Of course, Einhorn could underperform another 3 years and/or the stock market could tank. In those cases one could even imagine some more discount on the book value. Nevertheless I see better a upside than downside at this point for Greenlight in the coming 2-3 years. On top of that I think the “Einhorn come back” bet is relatively uncorrelated to the overall market.
The downside case would mean further losses from Einhorn, Insurance losses and a further detoriation in the P/B multiple. The probability is definitely not zero, but overall I do think the upside outweighs the downside.
For the portfolio I therfore assume to buy a 2,5% position at ~18 USD per stock.
What’s my edge or what do I know that others don’t ?
Finally one should always ask oneself the question: What do I know more or why am I a better shareholder than those who sell at those prices.
For me, I think those are the major points to justify an investment:
– I have no problem with having an underperforming stock in my portfolio at year end (many public funds do)
– I have followed David Einhorn over quite some time now and I think he is a very good investor and will come back at some point in time
– Few people do allocate money to underperforming managers although that is statistically the best time to do so
Another interesting observation: Only one analyst is following this company…..