Tuesday, March 24, 2009

Larry Bottom Lines It, Learns From Volkswagen Lesson

Glenview steps up to the Citi, BofA, JPM etc. plate and announces it also has "begun the year in a profitable fashion." Too bad there is no public stock to generate a short squeeze.
Larry, Bottom Line it For Me

We recognize that many of you, while you appreciate the completeness of the disclosure, just want the punch line.
Here it is:

1. We believe the majority of our losses will be recouped in the same securities we lost money in, as those securities rebound towards fair value.

2. A portion of the losses are mistakes, and while we believe we will eliminate our high water mark and grow your investment to new highs, we recognize that there are some situations where the losses are realized and will not be recovered.

3. Despite our results, our process is sound, our team continues to predict the earnings and cash flows of companies well, and ultimately these fundamentals will again carry the day as the primary determinant of securities prices.

4. Given the depressed starting point, we expect the coming years to exhibit higher than average returns though we can not predict the exact timing, and we obviously were very wrong in our assessment of 2008.

5. I remain fully committed to Glenview and its investors and remain intensely focused on restoring the performance of your investment and the reputation of our firm.

6. We have begun the year in a profitable fashion, and I expect that to continue and accelerate.
And here is to hoping Glenview did not short Citi at a buck:

Clearly our largest disappointment of the year is losing 5% of our portfolio on Volkswagen. We described our investment position fully in our last quarterly letter, and today the shares are lower in price. However, between those times we were forced to cover our position at hugely unattractive prices based upon the following events.

1. We believed and believe that Porsche did not and does not have the capital or intention to purchase a VOW controlling stake at prices above €300 per share.

2. As we set forth in our prior thesis and continue to believe, the achievement of a "domination agreement" would require Porsche to offer to buy not only the remaining common shares but also the remaining preference shares outstanding. In total this equates to approximately 180M shares, or €18B for every 100 of price. We do not believe that such an offer is attractive, feasible or financeable in the current environment. For reference, VOW will earn approximately €3 per share this year down from expectations of €11 per share and, like most automotive companies, VOW is burning cash.

3. Porsche's ability to finance the purchase was based upon a syndicated credit line of €10B, which expires in 2012, but which can be pulled from them in March of this year based upon various conditions that we believe have been triggered. The lines of credit have already been reduced to €7.8B by the banks, and Porsche remains in active negotiations with its lenders.

4. From October 17th through October 24th, the share price of VOW fell from €400 to €210. Some market participants speculated that Porsche was short put options on Volkswagen stock and would suffer losses or be required to post collateral should VOW shares continue to decline. We can not independently corroborate such beliefs.

5. On October 26th, Porsche issues a press release disclosing a significantly higher stake in VOW shares than the market presumed, indicating that they held 42.6% of the shares and with options had an ability to acquire up to 74.1% of the company. Given the fact that Lower Saxony held a 20% stake, the market was in a panic that only 6% or 18m shares could be available for float and that the short interest might exceed the float.

6. As such, the shares appreciated significantly on Monday October 27th and Tuesday October 28th, rising 130% on Monday from €210 to €470, and over 350% to €918 over a two day period ending Tuesday night with a €918 closing price. At the peak, Volkswagen had a market equity capitalization larger than any company in the US or EU with a total market equity capitalization of $456 billion on a fully diluted basis. For reference, that is 5% of the current value of the entire US equity market.

7. It was during this period that risk managers at the prime brokerages decided that the extraordinary share price movements required that they increase margin postings on a short position in Volkswagen from 25% of the value of the position to more than 10x that amount, and since the value of the shares more than quadrupled, each 1% short position on Friday became a 4.5% short position by Tuesday and a 12-15% margin posting. Thus, to carry a 5% short position at Friday's values would have required that 60% of our NAV be posted to support just one position. Once senior management of prime brokerages became fully aware of the situation, they moved to modify their stance, but the forced covering had already occurred and the damage was done.

8. Fundamentally, we don't believe that there was a short squeeze based upon available borrow:

a. While Porsche held options on 31% of the company, they lacked the financial resources to exercise those, and those shares were still available for stock loan as they were held by banks who sold the options to Porsche. Therefore, we believe that the true available float for borrow was approximately 120M shares versus a total short position of about 20M shares and a total shares borrowed of about 40M.

b. We ourselves, cognizant of a possibility of buy-in, had locked in term borrow for periods of 3-6
months in volume equal to 2x as many shares as we were short to ensure that we could not only ride out but, in fact, short into any squeeze.

c. Despite these protections, and the fact that we felt we had thought through the trade completely, we did not anticipate that the prime brokerage community could view an automotive company at 1-300x earnings and greater in value than Exxon Mobil as be the riskiest short in the marketplace necessitating multiples of capital posted as margin. Our imaginations were not large enough.

9. Subsequent to these events, Bafin, the SEC of Germany, has opened an investigation into Porsche's possible manipulation of Volkswagen shares for their own gain. The behavior that some have questioned is as follows:

a. A German company must disclose an equity stake in a company of the size Porsche accumulated through call options if such options are to be share settled. According to Porsche, these options are possibly cash settled at the option of the holder. However, common sense dictates that it is a nearly impossible task for a financial intermediary to cash settle an option on 30% of a company that is subject to a possible takeover attempt by the options' holder. We know of no sophisticated financial counterparty that would knowingly enter into such an arrangement unless they had some means to deliver shares in lieu of cash. Should such an agreement exist, that would require Porsche to have disclosed its position sooner, and through their lack of disclosure, they would have damaged market participants by knowingly manipulating VOW shares. Since they sold shares in the open market at elevated levels, they had a financial motive to attempt such a maneuver.

b. The timing of Porsche's announcement may have been timed to defend against capital postings required on put positions. Such positions may not have been adequately disclosed.

c. Porsche may have failed to disclose material issues related to its possible financing of such an

d. Porsche made conflicting public comments about their intentions with respect to Volkswagen, which may have been an attempt to influence VOW's share price.

Fundamentally, we continue to believe that VOW shares are overvalued at today's price of €218 and we remain short, though in small enough size to ensure that we can see the trade to completion without interruption. Mark Horowitz, in his role as Glenview's general counsel, is monitoring all legal and regulatory aspects of the Volkswagen situation, and we will pursue any and all remedies for our clients that are appropriate. We have taken steps to ensure that such a situation never happens again with our prime brokerage partners who, prior to and subsequent to this situation, have been value added partners of Glenview and supporters of the best interests of our clients.

I'm often asked about the lesson learned from VOW. I would simply state that our lesson is to be humble – literally anything can happen.
Someone sure got fired over that one. Sphere: Related Content
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