Greenlight Capital's David Einhorn is best known for one high-profile short, not for his long investments. At a May 2008 investment conference, he presented his thesis for his short of investment bank Lehman Brothers, pointing to accounting inconsistencies and a highly precarious financial position. He concluded that federal regulators ought to "guide Lehman toward a recapitalization and recognition of its losses." Less than four months later, Lehman Brothers was filing for bankruptcy.
Sure, Einhorn called Lehman correctly, but perhaps that was just a fluke. What does his long-term track record look like? Well, between May 1996 through 2015, his hedge fund, Greenlight Capital, L.P., returned 16.5% on an annualized basis, net of all fees and expenses. That's at least 6.5 percentage points ahead of the S&P 500 on an annual basis -- a remarkable record for a period stretching almost two decades.
Add to that the fact that Mr. Einhorn invests on the basis of fundamentals, and the Greenlight portfolio seems like a decent place to look for stock ideas. So let's have a look at one of the big moves Greenlight made last quarter.
In the first quarter, Greenlight added heavily to a position in online business directory Yelp Inc (YELP 0.32%) that it had initiated during the previous quarter. At the end of March, Greenlight's 3.23 million shares were worth $64 million. That may not sound like much for a multibillion-dollar portfolio, and indeed, it represented just 1.1% of the value of Greenlight's reported holdings, but it's enough to make Greenlight Yelp's fourth-largest shareholder, with a stake of nearly 5% stake, according to data from Bloomberg.
A "dominant search and review website"
Einhorn described his thesis for the investment in his first-quarter investor letter:
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. ...
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.
(Note: The stock has already benefited from something of a rerating, having closed at $25.20 last Friday.)
This is a classic value-investing approach: Identify great businesses that have fallen into disfavor with the market due to temporary factors that do not alter the company's long-term prospects. In fact, Einhorn thinks the business is improving:
YELP is adding more transaction-based revenue, gradually relocating its sales force to lower-cost cities and providing more reporting tools to its customers to better illustrate the robust ROI of dollars spent with YELP.
What's it worth?
Next, Einhorn tackles the valuation (the word "value" is not an afterthought in "value investing"). No self-respecting value investor would begin to make a decision about whether or not to buy an asset without their own estimate of its intrinsic value. Einhorn sees two scenarios:
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.
In other words, it's "heads you win big, tails you win less" -- not a bad proposition, assuming Einhorn is correct. Better yet, he sees another avenue by which shareholders could get full value for their shares:
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.
A medium-term value play
Given this information, should you buy Yelp shares, too? First, let me make it clear: Investors should never piggyback on a professional investor's stock picks without doing their own research. With that caveat in mind, let's summarize Mr. Einhorn's pitch:
- Yelp enjoys an enviable competitive position in local search, and the business is only improving.
- By 2019, the stock could trade at more than twice its current price under an upside scenario. The downside scenario has the stock worth roughly its current price ($19.88 * 1.30 = $25.84).
- A third scenario in which Yelp is acquired would probably enable shareholders to realize full value
Is that enough to invest in Yelp? Paying more than $25 per share does not offer the same margin of safety relative to buying them at $21.16 (Greenlight's average cost), but I think Yelp could still be a decent investment for the enterprising investor who has the time and experience to monitor the position.
However, I'm not convinced it's a good candidate for a long-term buy-and-hold investment. Yelp may well have established some sort of competitive advantage, but it's difficult for me to assess the durability of that advantage. Yelp itself will tell you the market for online business information is "intensely competitive" and it is competing with a little search engine called Google. As such, it's hard (for me) to feel reasonably confident regarding the state of the market and Yelp's position in 10 years' time.