Dear Partner:
The Greenlight Capital funds (the “Partnerships”) returned 3.0%,1 net of fees and expenses, in the first quarter of 2016. It has been a while since we’ve had a profitable quarter to report. Though we would like to make it a habit, trying to manage for quarterly results is really not our philosophy. We think one of our advantages is the ability to be more patient than others, especially as investment horizons appear to be getting shorter.
It was a strange quarter. The S&P 500 spent the first half of the quarter going straight down. Then in the spirit of “never mind”, it turned on a dime, recovering all of the loss and then some. Continuing the game of lower and beat, most companies beat low-balled fourth quarter estimates and many further lowered targets for 2016. In 2015, the S&P 500 companies collectively earned $117, which was 6% less than expected at the beginning of the year.
Yet each quarter when companies reported, earnings were about 3% higher than expected, with roughly two-thirds of the companies exceeding estimates. Impressively, there were 32 companies in the S&P 500 that earned less last year than was expected at the beginning of the year, and reduced expectations for 2016, while somehow managing to report positive surprises every quarter in 2015.
2016 looks to be more of the same. Since the beginning of the year, bottom-up consensus estimates for S&P 500 earnings have fallen from $126 to $120. Companies are again poised to succeed at clearing a continually falling bar.
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The “bubble basket” of shorts declined about 13% as several companies within the basket disappointed and de-rated and the market shifted emphasis away from momentum stocks for part of the quarter.
Gold advanced from $1,061 to $1,233 per ounce for a number of reasons. Foreign central banks implemented even more aggressive, and in our view, counter-productive monetary policies. Also, the U.S. Federal Reserve reduced its forecast for future rate hikes in response to a variety of fears/rationalizations including foreign exchange rates, corporate credit spreads, and equity market volatility. Notably, the Fed’s “data dependency” doesn’t appear to relate to employment, which continues to improve, or core inflation, which is now running above its 2% target. We believe the increasingly adventurous monetary policy is bullish for gold.
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We had two significant losers during the quarter: ? Resona Holdings (Japan: 8308) fell from ¥591 to ¥402 in response to the Bank of Japan implementing a negative interest rate policy. This will be a headwind for all Japanese financials. Nonetheless, we believe Resona has overshot to the downside. The shares presently trade at 0.6x book value and less than 6x expected earnings. This seems too low for a bank earning a double-digit ROE without significant credit or capital issues.
SunEdison (SUNE) collapsed from $5.09 to $0.54. In January we negotiated with the company to add an independent director to the board. Unfortunately, and to our surprise, the patient was already in terminal condition. Obviously, we underestimated the fragility of the situation.
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We purchased Yelp (YELP) at an average price of $21.16. YELP is a dominant search and review website for local businesses with roughly 200 million unique monthly visitors and the 21st most popular mobile app in the U.S. The stock has suffered due to missed expectations and anxiety about an upcoming negative documentary. YELP is adding more transaction-based revenue, gradually relocating its salesforce to lowercost cities, and providing more reporting tools to its customers to better illustrate the robust ROI of dollars spent with YELP. If the company executes its current plan, by 2019 it will double revenues and earn $300 million of EBITDA at a 35% margin. A peer group EBITDA multiple would imply a $55 stock price. Alternatively, YELP could pare back and operate only in its top 20 markets – using a similar EBITDA multiple, we estimate 30% upside in this “downside” scenario. We also believe that the company has strategic value and that it has been approached by multiple potential acquirers. Should YELP’s board ever decide to auction the company, a bidding war could emerge. Finally, we’ve reviewed the criticisms raised in the trailer to the documentary and we are comfortable that they won’t have a negative impact on our investment thesis. YELP shares ended the quarter at $19.88. We rate them five stars.
We also added a new macro position in natural gas through the purchase of 2017 and 2018 calendar strips at an average price of $2.71 and $2.84 per MMBtu, respectively. Natural gas prices are not high enough to justify drilling in all but the very best locations. The industry has responded by dramatically reducing drilling activity. As existing wells deplete, supplies should fall. The high cost of liquefying and transporting natural gas limits competition to North American sources. Current inventories are high following a period of over-drilling and a record warm winter. However, the excess inventory is only a couple percent of annual production, which has already begun to decline. Normal weather combined with lower production could lead to a shortage within a year. The 2017 and 2018 strips ended the quarter at $2.77 and $2.87, respectively.
My Q1 +6%, NET OF FEES. David, call me, baby.