David Einhorn’s Q1 2023 letter to Greenlight Capital investors, discussing his long position in Kyndryl Holdings (NYSE:KD). Full letter here.
Dear Partner:
Greenlight Capital’s Performance
The Greenlight Capital funds (the “Partnerships”) returned (1.3%)1 in the first quarter of 2023, net of fees and expenses, compared to a 7.5% return for the S&P 500 index.
Many have commented that in the beginning of 2023, whatever worked in 2022 didn’t work and vice versa. That seems about right to us. During the quarter, our longs gained 9.9%, while our shorts lost 10.8% and macro lost 0.4%, net of fees and expenses.
Green Brick Partners
Starting with the good, Green Brick Partners (NYSE:GRBK), which was our largest loser in 2022, was, conversely, our largest winner in the first quarter. The shares advanced from $24.23 to $35.06. Analysts have raised 2023 EPS estimates from $3.16 to $3.34. While that might not seem significant, it reflects a reversal of the downtrend in those estimates.
With the market gaining confidence that the earnings expectations had fallen too far, the shares have rerated to just over 10x estimated 2023 earnings (but still less than 6x trailing earnings). GRBK has the highest gross margins, and nearly the highest ROE, in the industry.
It also has an enviable land position in some of the most desirable markets. The $3.34/share earnings estimate for 2023 would be about a 15% ROE. If that is what a down year looks like, it’s hard to understand why a single digit P/E would be warranted.
Kyndryl Holdings
Our second biggest winner was Kyndryl Holdings (NYSE:KD). KD is an IT services provider that was spun off from IBM in late 2021. Though we began acquiring our stake around that time, we haven’t previously discussed this investment as we were patiently building the position.
This proved to be a prudent approach, as the stock fell from $18.10 to $11.12 per share in 2022. So far in 2023, the shares have rebounded to $14.76. Over our 12-month buying period, the Partnerships acquired their shares at an average price of $11.37.
KD is a “bad business” spin-off. Prior to the spin, IBM often positioned its services unit as a loss leader in order to sell more hardware. These service contracts last for several years and, in aggregate, KD has no pre-tax income.
Yet the turnaround strategy is straightforward. By no longer being part of IBM, KD can now offer solutions from multiple vendors and, as contracts expire, it is better positioned to raise both pricing and margins. About 60% of KD’s contracts earn greater than a 20% gross margin, while the other 40% are about breakeven.
We believe that many of the no margin customers will accept higher prices. Our field work has made us believers in KD’s excellent reputation, while concluding that there aren’t any competitors willing to work for free.
That said, it will take several years to work through the pre-spin backlog of no margin contracts, and it is inevitable that there will be some customer churn, which will make KD an unexciting story from a revenue growth perspective in the near term.
With an enterprise value of $4.5 billion and $17 billion of revenues, KD trades for less than 0.3x sales. Meanwhile, all of its peers trade for at least twice that multiple. We expect the shares to rerate over time as KD closes the margin gap with its peers.
A Diffcult Year For The Short Portfolio
It is our view that rate cuts are not going to happen this year, while the market is expecting them in the back half of the year. As such, we added to our interest rate positions via Fed Funds futures.
Expressing this thesis directly means that we are only subject to the central bank’s decisions for the balance of the year, rather than being subject to the market’s expectations.
As mentioned above, the short portfolio had a difficult quarter. While we will continue our policy of not discussing individual open short positions, we can make a couple of observations. First, covering the bubble basket shorts prevented them from being material losers during the quarter.
Oak Street Health
Second, we will discuss Oak Street Health (NYSE:OSH), which we closed out after costing us 0.8% (net) during the quarter. CVS Health Corporation (NYSE:CVS) is buying OSH for $39 per share, or about $10 billion.
When shorting, there is always the risk that someone with deep pockets will buy out the company at a silly price, or maybe even at twice a silly price. CVS is worth $115 billion (or it was the day they announced the deal; subsequently, CVS’s shares have fallen and it’s now worth $93 billion), so it can afford to piss away $10 billion.
OSH is in value-based care, which has become a trendy segment of the market. Most of the “value” comes from doing a more thorough and aggressive job of documenting how sick a patient is, so as to maximize Medicare payments.
OSH operates 169 clinics (costing between $1.5-$2 million to build) in mostly lower income neighborhoods and employs 600 doctors. CVS projects that in 2026 the pro forma entity will have 300 clinics and “embedded EBITDA” of $2 billion, plus over $500 million of synergies.
Brighthouse Financial
Brighthouse Financial (NASDAQ:BHF) was the other material loser during the quarter, with shares declining by 14%. In response to the bank failures, partially caused by a few banks buying long duration bonds that fell in value when interest rates rose, the market sold other industries that own long duration bonds as well.
Life insurers went to the top of the pile and, well, BHF is a life insurer and owns a lot of bonds. Though BHF is a beneficiary of higher rates by virtue of having very long duration liabilities, which are quite different from short-term deposits that can leave abruptly, the market decided to simply ignore this difference and focus on its exposure to bonds.
We don’t believe any of the concern is BHF specific, as other life insurers suffered similar stock performance.
In addition to closing out the bubble basket shorts with large gains, and OSH with a moderate loss, we also exited Victoria’s Secret with a small loss over an 18-month holding period.
At quarter-end, the largest disclosed long positions in the Partnerships were Brighthouse Financial, CONSOL Energy, Green Brick Partners, Kyndryl Holdings and Teck Resources. The Partnerships had an average exposure of 106% long and 50% short.
Best Regards,
Greenlight Capital, Inc.
Read the full letter here.
Or see other exclusive hedge fund letters.
