A Cup or A Thimble of Joe?

David Einhorn of Greenlight Capital gave a terrific presentation at the Value Investing Congress, titled "Field of Schemes." His target is what's left of the old St. Joe Minerals Company, which shrunk down to a land trust holding timber and mineral assets, now called St. Joe, a public company.

Bruce Berkowitz, manager of the Fairholme Fund, is a lionized investor whose motto is "Ignore The Crowd." Fairholme owns 29% of JOE, according to the last company proxy. Other large owners include T. Rowe Price at 15% and Janus at 12%. Fidelity is shown as owning 6% of the outstanding equity.

As a preface, Einhorn mentions that representatives of the company refused to speak to him as he was doing his research. This violates one of my first principles, paraphrased as "speak to everyone with a legitimate interest in the company, and give them their due." Short sellers often do the best research on Wall Street, with a few exceptions. The other place where good research is done are the distressed debt desks of places like the old Lehman Brothers, and Larry McDonald's book is definitely worth reading for how good research is married to trading.

A CFO can always learn from speaking with the quality, institutional short sellers. There's an old Arab proverb that applies:"Keep your friends close, and your enemies closer." JOE's blowing off David Einhorn was bad judgment, bad business, and bad for the existing shareholders. I also suspect that Einhorn himself tried to speak to Bruce Berkowitz--it would be the first stop given Fairholme's stake--but the NYT reports that Einhorn's calls went unanswered.

The first thing I noted was the trouble beginning when JOE chose a CEO, Peter Runnell, who came from Disney. A decisive step was taken to turn JOE into a real estate developer, a competence for which the company had no history, no depth of management, and no relevant experience on the board of directors. Runnell left in 2008.

Much of the work shown in Einhorn's presentation represents good, solid, fundamental grunt work, with his staff poring over local government filings and regulatory filings which filled in the mosaic where the company's disclosures were inadequate or uninformative. I've spent lots of time in court houses and government offices as an analyst, and there are rich veins of information, but it is tedious and time consuming to go through it. Kudos to Greenlight Capital for doing the work.

Einhorn notes that over the past ten years, JOE has earned some $710 million in pre-tax profits from the sale of low basis cost properties from its beginning portfolio. In other words, its quality of earnings was not good, because of one-time items like gains and because it was not sustainable. Half of the quality portfolio has been sold, according to the presentation.

The company's pitch shifted once much of the quality real estate was sold, and Fairholme reports were about JOE owning land for the Panama City Airport, the construction of which would open Bay County to a huge influx of tourism into an area where JOE was developing resorts, conference centers, homes and golf courses. Einhorn goes into the realities of the fact that JOE's current land holdings are outside of the airport, and the company can't benefit directly from development because it had to give some of the land away to governmental bodies in order to develop it. Only one gate out of seven in the airport can accommodate the jumbo jets flown by Southwest and other major carriers. Current prospects for the airport are uncertain.

Other issues surround the lack of transparency in JOE's disclosures about the amount of capital investment it has made in its properties, the capitalization of expenses, and the fact that properties are reported as developed if one home has been built though the majority of the site is fallow. Einhorn estimates, with reasonable logic, that developed lots in the RiverTown development project are carried on the books at $74.5 million versus his estimated market value of $6 million. He goes through several other projects. The bottom line is that the company has taken relatively little in the way of impairment charges to-date, and based on the fact that the Florida market has been hurt significantly worse than most other US markets, current market values suggest that significant additional write-downs need to be taken. Einhorn's provocative floor for the share price is $7-10 versus a quote of $20.20 at this writing.

He derives the $7-10 number from market value estimates of the remaining rural land in the portfolio, leaving aside some unknown value for 41,000 additional acres of entitled acres that could be developed in the future.

It will be interesting to see where this discussion goes and how the board and the auditors deal with the questions raised. Stay tuned.