Thursday, September 13, 2012

David Einhorn Meets a GE Turnaround Expert

I just finished David Einhorn's book, and though it wasn't an easy read, I learned a lot, which is why I seek out his presentations and speeches.  Several years ago, his presentation at a Graham and Doddsville seminar on St. Joe was funny, illuminating and right on the mark. 

With all the talk about financial companies, I had to laugh as I read the author's tale of doing a "capital structure arbitrage" on Conseco, Inc.  Conseco's bonds were priced to yield 20% in 2000, suggesting extreme distress.  Meanwhile, he points out that the company's shares were priced as if things were hunky dory.  Greenlight's strategy was to go long the bonds and to go short the equity. 

Gary Wendt, a 24 year veteran of General Electric, had earned a reputation as a turnaround artist, working on some ten business unit restructurings within the Jack Welch-led behemoth.  Wendt is a graduate of the Harvard Business School. According to one press bio, after taking command of GE's Capital Services business in 1985, he grew it into a business with $255 billion in assets worldwide and 67,000 employees.  As Bill Gross eventually wrote in one of his letters, GE Capital and its balance sheet were the engine behind the stock performance of General Electric.  He was brought in to turn Conseco around.

In 2000, the board at Conseco paid Wendt $45 million in cash and 3.2 million options upfront to turnaround a troubled specialty finance business.  This should have been a walk in the park for Gary Wendt and a boon to the poor shareholders.  True to his GE heritage, Wendt, according to the author, promised an "immediate turnaround" by bringing in Six Sigma black belts with their dark arts, to improve the operations.  The market bought into the promises, and the 20% yielding debt was soon priced to yield 11%, even without any specifics about how the business was going to be rejuvenated. So, Greenlight Capital had already made money on its long bond position.  The reader, however, can feel Mr. Einhorn's antennae going up. 

Thirty investors and analysts were invited to Conseco's midtown New York offices, and they were asked to wait in a warm conference room until the entire invited group had assembled.  When all the Wall Street participants were seated, a minion brought in Mr. Wendt's "throne," a specially crafted chair that was put at the center of the conference table. (I have actually witnessed this phenomenon working with another former GE executive who brought his GE furniture with him to a new assignment.  It must be the karma of success residing in the handcrafted wood and leather.)

After a lengthy pitch by the CEO, a question and answer period began.  Einhorn recounts that whenever a question concerned numbers or financial details, Wendt's response was "Someone will get back to you." 

Now, David Einhorn didn't have to run any complicated Excel spreadsheet models to make his decision: "I had seen enough."  Greenlight Capital sold out its bond position for a profit, and it then added to its short equity position.

Gary Wendt went to work cutting costs and restructuring debt, straight out of the corporate finance playbook.  According to the Indianapolis Star,
" In his first year at the helm, Wendt outsourced call center work to India, shut down the company's unprofitable medical insurance line and dispensed with the art collections, airplanes and other conspicuous trappings of the Hilbert era. Stock prices rose in response, to nearly $20 in the summer of 2001." (The stock had been as low as $5)
Einhorn recounts that the company issued irregular "turnaround memos" which were largely self-congratulatory, at intervals that seemed chosen to "goose the stock."  Each release raised more questions about the numbers and how the business model worked.   The company provided no answers.  "The stock kept going up, until it didn't." 

The Indianapolis Star's account of the denouement is a bit fuller than the author's:
"... investor confidence did not hold, particularly after a third-quarter 2001 write-off of $471 million that shocked many investors. The company was also burdened by more than $500 million in loans to its own directors, including Wendt, who had used the money to invest in Conseco stock.

After more than two years, during which the stock continued to fall to a low of $.07, and amid talk of impending bankruptcy, Wendt resigned as chief executive officer."
Like Sam Zemurray, the Banana Man, said, "Go and see for yourself."  Having come into that investor meeting with all the research homework done, and the senses quickened by having skin in the game, there was nothing better for a savvy investor like David Einhorn to do than to sit across a table from Gary Wendt, look him in the eye and take a reading of what kind of person was managing his investment.  It's a great story.  Beginning around the same time period, the specialty finance sector produced fizzled growth rockets like Green Tree Financial, Metris, IndyMac, Washington Mutual, and Countrywide Financial.  There is nothing new on Wall Street.

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