Covered short of a David Einhorn stock for 27% profit in less than two months.

On September 17th, I mentioned that I had shorted one of David Einhorn's holdings, Einstein Noah Restaurant Group (Nasdaq: BAGL), at $13.78. I found BAGL initially using ShortScreen's screener: at the time, it was one of the 50 most-distressed stocks trading at $10 or above. Earlier today I covered my short position at $10.05, for a 27% profit in less than two months.

If you had followed me on this particular trade but shorted only 100 shares, your capital gain would have paid for an annual membership to ShortScreen more than twice over.

Bagel Dog

Last month, I mentioned I shorted Einstein Bagels (Nasdaq: BAGL) ("New Short Position: BAGL"). Today, BAGL was added to the Zacks #5 Strong Sell list.

New Short Position: BAGL

I mentioned this in a previous comment thread, but I shorted a few shares of Einstein Noah Restaurant Group (Nasdaq: BAGL) earlier today at $13.78. This company has an Altman Z"-Score¹ of -3.2. A score below 1.1 suggests a company is at risk of bankruptcy within 1 to 2 years. It wouldn't be the first time an Einstein Bagels went bankrupt; a previous iteration of Einstein/Noah Bagels went bankrupt nine years ago. Insiders have been selling BAGL this year. The company also has negative working capital, over $117 million in total debt, less than $4 million in cash, and it's had a big run-up this year that doesn't seem to be justified by fundamentals.

On the other hand, David Einhorn, one of The Guru Five, is the largest investor in BAGL², so bear that in mind. For my part though, I'm not going to let a guru's ownership of a stock keep me from shorting it. I did that last year, when I was bearish on USG, but didn't short it because Warren Buffett owned it. These guys put their pants on one leg at a time like the rest of us, and they often have different considerations than the rest of us do with these sorts of positions.


¹Z"-Score is the designation for the modified, four-term version of the model recommended for publicly-traded (non-financial) non-manufacturing companies.

²Einhorn appears to have acquired his stake when he helped recapitalize the company after its bankruptcy, so his average cost here is probably very low. I don't have the energy to look up the exact figures, but feel free to do so yourself if the spirit moves you.

David Einhorn on Lehman Last Year

Via Seeking Alpha again, Amit Chokshi's notes on David Einhorn's presentation on his Lehman (NYSE: LEH) short idea at last November's Value Investing Congress in New York:

Value at Risk (“VaR”) is not appropriate for measuring risk:

• Einhorn compared investment bank VaRs to actual results for recent quarters, which showed that actual results were off by multiples of VaR estimates in some cases.
• Risk managers should focus on the tails of bell curves and also be prepared for fat tail risk - 5-10 sigma events are not uncommon¹.

FAS 159: Profit from One’s Demise

• Fair value accounting standard that allows asset and liabilities to both be marked at fair value.
• This accounting mechanism allows for income to be recognized as liabilities are marked down to fair value.
• FAS 159 is acceptable for market risk but not for idiosyncratic risk.
• The Street is comfortable with FAS 159 but does not seem to grasp all aspects of the ruling.

Lehman Brothers (LEH) – short idea

• Looks vulnerable due to lack of transparency regarding writedowns
• Could be following its “playbook” from 1998 liquidity crisis

LEH had mortgage exposure but took no writedowns

The market recovered and LEH pulled through

Could that happen now?

• LEH stock has held up because of “good” quarters

2008 EPS estimates remain unchanged at $7.75 which would follow a record year in 2007

Sellside believes the chance of a writedown at LEH is minimal

LEH 10-Q reveals no significant loss on Level III investments which Einhorn is skeptical of

• In 2006, fixed income accounted for 48% of LEH income while securitizations accounted for 15% of income.
• LEH should be much more exposed to losses than what has currently been reported.

LEH either recognizes larger losses (which will be a negative surprise) or LEH will likely under-earn competitors that have taken larger losses and cleaned up their balance sheets relative to LEH.

Lehman was trading at about $60 per share last November when Einhorn gave this presentation. Today it closed at $7.25 per share.



¹Not to be picayune about it, but if I remember my statistics correctly, by definition, 5- and 10-sigma events are of course uncommon, and also by definition, bell curves (normal distributions) don't have fat tails. I think Einhorn's point (simplified, apparently, for his audience) was that in finance returns usually do not follow normal distributions; their distribution curves have fat tails, indicating that extreme events are far more likely to occur than they would under a normal distribution. This is true, and has been, as far as I know, widely accepted for some time.