Fooling Some of the People All of the Time, a Long Short (And Now Complete) Story, Updated With New Epilogue by David Einhorn Page A
Authors: David Einhorn
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prior to exiting them. Comparing exit prices versus the previous quarter’s carrying value after Allied had an opportunity to revalue the investment to reflect the pending sale price is a meaningless exercise. When you have perfect knowledge, it’s really easy to get the valuation exactly right. Certainly, it does not validate Allied’s general valuation practices.
Loeb wasn’t done. He asked if Allied’s business resembled a closed-end fund. Walton responded that Allied is actually an operating company, providing significant managerial assistance to its portfolio companies. The transactions are privately negotiated, and Allied has board observation rights or serves on the board in every deal. Allied provides significant assistance in financing, mergers and acquisitions (M&A), employee benefits, marketing and all sorts of areas to help grow the business. “So our business is not a passive buy-and-hold and trade business,” Walton said. “It’s an actively managed portfolio . . . deeply involved with each management team to grow the business. And it’s a very hands-on process. We have thirty-five investment officers handling 130 companies.”
The next private-equity investor I meet who says he just puts money in and sits on his hands will be the first. They all say they provide services and add more than money to their investments. Still, they realize the funds they manage are investment vehicles, and few, if any, would consider themselves to be “operating companies.”
The time-consuming nature of negotiating and structuring the entry and exit of each investment and looking for new opportunities suggests that the thirty-five investment officers didn’t have a lot of time left to make large contributions to marketing and human resources at 130 companies. In 2001, fees totaled $46 million, or $1.3 million for each of the thirty-five investment officers providing part-time assistance. At those implied rates, it was no wonder most of the fees came from controlled companies that were not deciding for themselves whether to engage Allied for auxiliary services.
“That wasn’t really my question,” Loeb said. “The observation was that—what compelling argument would you make to invest in your company?”
“Dividends,” Walton said.
Now we’re at the heart of the matter. Allied has paid a steady or rising dividend for over forty years. It has paid the dividend whether it had profits to cover it or not. Allied’s dividend is a holy covenant between itself and its shareholders. Its payment proves to them that all is well. After all, you never have to restate a dividend.
Just as the Elán bulls had argued that Elán was a lousy short, because it would never miss its earnings forecast, the Allied bulls argue that Allied’s dividend is unlikely to be cut regardless of whether it deserves to be cut. They raise the same question: “How are you ever going to get paid on your short if Allied never cuts the dividend?” Of course, when Elán was ultimately revealed to be a fraud, it did miss the earnings forecast, and the short worked out well.
As bizarre as this sounds, Allied’s “dividend” is not really a dividend . Traditionally, a dividend represents excess profit that a company pays to shareholders because it does not need to retain the capital in its business. Though Allied’s “dividend” of about 8 percent is about three times the average yield in the S&P 500, it isn’t a “dividend” in the traditional sense. Traditional companies that pay large dividends do not generally issue fresh equity because the dividends reflect an unneeded surplus of capital. However, Allied does not have excess capital. So, its “dividend” is not paid from surplus it doesn’t need to retain in order to maintain or grow its business. In fact, Allied routinely sells freshly issued stock to satisfy its ongoing need for additional equity.
Technically, Allied’s
Loeb wasn’t done. He asked if Allied’s business resembled a closed-end fund. Walton responded that Allied is actually an operating company, providing significant managerial assistance to its portfolio companies. The transactions are privately negotiated, and Allied has board observation rights or serves on the board in every deal. Allied provides significant assistance in financing, mergers and acquisitions (M&A), employee benefits, marketing and all sorts of areas to help grow the business. “So our business is not a passive buy-and-hold and trade business,” Walton said. “It’s an actively managed portfolio . . . deeply involved with each management team to grow the business. And it’s a very hands-on process. We have thirty-five investment officers handling 130 companies.”
The next private-equity investor I meet who says he just puts money in and sits on his hands will be the first. They all say they provide services and add more than money to their investments. Still, they realize the funds they manage are investment vehicles, and few, if any, would consider themselves to be “operating companies.”
The time-consuming nature of negotiating and structuring the entry and exit of each investment and looking for new opportunities suggests that the thirty-five investment officers didn’t have a lot of time left to make large contributions to marketing and human resources at 130 companies. In 2001, fees totaled $46 million, or $1.3 million for each of the thirty-five investment officers providing part-time assistance. At those implied rates, it was no wonder most of the fees came from controlled companies that were not deciding for themselves whether to engage Allied for auxiliary services.
“That wasn’t really my question,” Loeb said. “The observation was that—what compelling argument would you make to invest in your company?”
“Dividends,” Walton said.
Now we’re at the heart of the matter. Allied has paid a steady or rising dividend for over forty years. It has paid the dividend whether it had profits to cover it or not. Allied’s dividend is a holy covenant between itself and its shareholders. Its payment proves to them that all is well. After all, you never have to restate a dividend.
Just as the Elán bulls had argued that Elán was a lousy short, because it would never miss its earnings forecast, the Allied bulls argue that Allied’s dividend is unlikely to be cut regardless of whether it deserves to be cut. They raise the same question: “How are you ever going to get paid on your short if Allied never cuts the dividend?” Of course, when Elán was ultimately revealed to be a fraud, it did miss the earnings forecast, and the short worked out well.
As bizarre as this sounds, Allied’s “dividend” is not really a dividend . Traditionally, a dividend represents excess profit that a company pays to shareholders because it does not need to retain the capital in its business. Though Allied’s “dividend” of about 8 percent is about three times the average yield in the S&P 500, it isn’t a “dividend” in the traditional sense. Traditional companies that pay large dividends do not generally issue fresh equity because the dividends reflect an unneeded surplus of capital. However, Allied does not have excess capital. So, its “dividend” is not paid from surplus it doesn’t need to retain in order to maintain or grow its business. In fact, Allied routinely sells freshly issued stock to satisfy its ongoing need for additional equity.
Technically, Allied’s
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