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January 17, 2012
Greenlight Capital, L.P., Greenlight Capital Qualified, L.P. and Greenlight Capital Offshore (collectively, the “Partnerships”) returned 9.7%, 8.8% and 8.5%1 net of fees and expenses, respectively, in the fourth quarter of 2011, bringing the respective full year returns to 2.9%, 2.7% and 1.9%.1 Since inception in May 1996, Greenlight Capital, L.P. has returned 1,685% cumulatively or 20% annualized, both net of fees and expenses. To summarize the year: Never has so much work gone into making 2%. For all its ups and downs, dramatic headlines, and extremely high daily volatility, the market ended the year just about where it started. The S&P 500 index closed within a tenth of a point of its opening price. Other developed equity markets did worse. Most European markets were down double digits, the Japanese Nikkei index fell about 17%, and many emerging markets declined more than 20%. While outperforming the S&P 500 has never been our goal, this is the 13th consecutive year that we have done so, though this time by a trivial margin. Throughout the year we found very few places to make money, but we likewise kept our mistakes to a minimum. Our largest winner by far was our short of First Solar (FSLR), which fell from $130.14 to $33.76 per share and was the worst performing stock in the S&P 500. We also did well investing in various credit default swaps on European sovereign debt. For the second year in a row, our biggest loss came from positions designed to capitalize on an eventual weakening of the Yen. These positions cost us only slightly more than our position in Sprint (S), which declined from $4.23 to $2.34 per share in 2011. For the most part, our long portfolio went sideways. A raft of large holdings including Arkema, Aspen Insurance, CareFusion, Delphi, Delta Lloyd, Ensco, Marvell Technology, Microsoft, NCR, Pfizer (exited) and Travelers (exited) generally met or exceeded our operating expectations, but combined to generate an insignificant return. Even Apple, with sales and earnings growth of about 70%, saw its stock appreciate by just 25%. Perhaps the old saw about “cheap stocks getting cheaper” applies. However, these are all good businesses with good prospects. We believe that at some point the Partnerships will be better rewarded for these holdings. The global environment is very complicated. On the one hand, the Federal Reserve has taken a much-needed break from quantitative easing (at least for the moment). Accordingly, inflation in oil and food has abated, providing relief to the U.S. economy. Bearish forecasts that the U.S. was headed back into recession proved wrong for the third time since the end of the last recession.
Source: Greenlight Capital. Please refer to information contained in the disclosures at the end of the letter. 2 G rand Cen tr a l Tower 140 East 45 t h S tr e e t, 2 4 t h Floor N ew Yo rk, NY 10017 Phon e: 212-973-1900 Fax 212-973-9219 www.g reen ligh tcap ital. com
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On the other hand, Asia appears to be in much worse shape than it was at this time last year and could be a drag on the world economy going forward. Very few people trust any of the economic data coming out of China, making it difficult to gauge the situation there. Some of the smartest people we know have very dim views. The Chinese have been a leading growth engine for the last two decades and are largely credited with leading the world out of the recession in 2009. A change in their economic circumstances could really upend things. Finally, the European currency crisis has continued to worsen. The last year and a half has been an endless repetition of the dynamic depicted below:
Solution has no substance or won’t work
Announcement of meeting to solve everything (stocks rise)
The cycle looks like this: Time passes and the crisis deepens. Markets, eternal creatures of habit, begin to reflect the ensuing fear. Then, just as things appear ready to unravel, there is a reprieve, as red headlines race across the screen: “Sarkozy and Merkel to Meet at Deauville”, “Obama Phones Cameron”, or "Christine Lagarde Waves From Bus”. The market jumps. You'd think the media would quit falling for this charade, but having run out of clever headlines to describe the impending doom — ‘Eurogeddon’ Really? — they herald every briefing, meeting, assembly, and conference call. The market embraces these announcements as eagerly as the media, behaving as if any and all communication is equally constructive, and likely to yield a solution. The market continues to rise until the day of that summit, as all ears await a Grand Communiqué. Within minutes of any proclamation, the market may cheer with a final, celebratory spike. Upon evaluation of the actual statement, it becomes clear that either nothing has truly been agreed upon, or that
Page 3 Simpo PDF Password Remover Unregistered Version - http://www.simpopdf.com the plan is insufficient, impractical or just won’t work. The market sells off and the crisis deepens some more. Lather. Rinse. Repeat. Nonetheless, everyone is looking to these leaders for a solution. And it’s understandable that speaking and meeting are necessary steps. Yet, despite the endless telephone calls and summits, all we hear are repeated promises to “do whatever it takes,” which seems to include everything except making the necessary sacrifices that might actually resolve the crisis. The latest solution is a work-in-progress treaty being heavily negotiated that, in its current incarnation, will only need to be ratified by a subset of the Eurozone countries. While the leaders have committed in principle, there is significant risk that once the details emerge (and the necessary electorates are consulted), we will discover that some leaders pledged with their fingers crossed and, as with prior efforts, this too will fail to get the job done. 2012 may be the year in which the currency crisis will no longer be kept at bay by politicians buying time with empty promises. Maybe the fall of the Euro will be the 2012 catastrophe that the Mayans predicted. With these things in mind, our current strategy is to own cheap stocks of good businesses, largely in the United States. We are more net long equities than we have been in some time, as we believe that many stocks have reached a point where they are simply cheap enough to own even if some trouble awaits us. We are prepared for problems in Asia by continuing to speculate on a much weaker Yen. We have hedged the currency on our European equities, and continue to believe that European sovereign bond prices will fall regardless of whether the crisis is resolved through sovereign default or money printing. Finally, we continue to hold gold and gold mining equities, reflecting our concerns that global fiscal and monetary policies continue to tempt fate. In the fourth quarter, the Partnerships made gains on both our long and short portfolios, as the market rose and recovered most of its third quarter loss. While our shorts often fall prey to “man-made” disasters, it was unusual to see one of our longs benefit from a natural disaster. Floods in Thailand caused significant damage to many of Seagate’s (STX) competitors and component suppliers. STX’s hard drive manufacturing facilities were relatively unharmed by the flooding and the company has been able to capitalize on the resulting shortages, which has led to a dramatic improvement in the company’s near-term prospects. The short portfolio had two significant winners in the quarter: Green Mountain Coffee Roasters (GMCR) and FSLR. GMCR fell after announcing disappointing quarterly results that had been widely anticipated to beat expectations. The market also took little comfort in GMCR’s failure to provide any substantive response to the questions we raised at the Value Investing Congress, other than a blanket denial of wrongdoing. FSLR shares collapsed along with solar panel prices. The Solyndra scandal also hurt the company, as the Department of Energy denied FSLR some subsidies that had been baked into expectations. Ultimately, FSLR changed management and dramatically cut guidance. The Partnerships had no material losers during the fourth quarter.
Page 4 Simpo PDF Password Remover Unregistered Version - http://www.simpopdf.com During the quarter, the Partnerships established a new position in Dell (DELL) and reestablished a position in Xerox (XRX). DELL is a large seller of computer and technology products. We established our position at an average price of $15.53. DELL is another example where the recent business performance has exceeded the recent stock performance. While the computer business is mature, DELL has broadened its offerings over the last few years, so that about half its sales and more than half of its gross profits come from other products. DELL has roughly $7 per share in net cash and investments and currently earns about $2 per share (up from $1.50 in 2010). Accordingly, DELL’s P/E multiple is about 7x, and net of the cash and investments, it is less than 4x. This reflects a valuation usually associated with collapsing businesses. We expect DELL to continue to grow its earnings per share, albeit at a modest rate. Over the years, DELL has done a miserable job of allocating capital. During the dot-com heyday, when the P/E multiple was sky-high, DELL routinely plowed every available dollar back into share repurchases. After the tech bubble burst and the P/E came down to earth, it opted to hoard cash and pay fancy multiples to acquire growth. More recently it seems to have figured out that buying back stock at nosebleed prices makes no sense, but share repurchases at bargain prices can add real shareholder value. During the first three quarters of 2011, DELL repurchased 7.5% of the company and has the balance sheet to do much more. DELL shares ended the year at $14.63 per share. XRX is a document management provider that entered business process outsourcing when it acquired Affiliated Computer Services (ACS) in February 2010. The combination allows XRX to sell more value-added services to its current customers and apply XRX’s technology to deliver ACS's services more cheaply. This is our second investment in XRX since the acquisition. The first time, we bought with the stock price around $9.35, and sold with a modest gain over concerns about XRX’s Japanese exposure after the earthquake. That issue appeared fully discounted by the market during the fourth quarter when we re-established a position at $7.61 per share, which is less than 8x estimated 2012 earnings. In the first nine months of 2011, XRX signed a significant amount of new multi-year outsourcing services contracts. XRX has been aggressively cutting costs within the legacy ACS organization. Over the long-term, XRX is expecting over 6% revenue growth and 10-15% adjusted EPS growth. XRX expects to spend $1.0-$1.4 billion on share repurchases in 2012, which should make a good dent in the share count given its current equity capitalization of $11 billion. XRX shares ended the year at $7.96 each.
We exited several significant positions during the quarter. We sold Becton Dickinson (BDX) with a slight gain in response to disappointing guidance given with the release of the third quarter earnings. We sold CVS because it had appreciated and we wished to redeploy the capital into cheaper ideas. We sold Employers Holdings (EIG), a company that could simply never execute over the nearly five years that we held the stock, at a break-even result. Finally, we exited Travelers (TRV), with a double digit return, because the recent losses due to various catastrophes have hampered its share repurchase program, causing us to cut our forward earnings forecast. On the short side, we closed out our FSLR position. This was one of the most profitable shorts in the history of the Partnerships. We also closed out our short of
Page 5 Simpo PDF Password Remover Unregistered Version - http://www.simpopdf.com Diamond Foods (DMND) which, while small, was one of the fastest performing shorts in our history. Greenlight Capital, Inc. and its affiliates registered as investment advisers with the Securities and Exchange Commission (SEC) effective as of January 4, 2012. Over the last six months we have prepared for registration and we don’t foresee any operational changes. We have promoted Sean Farrell to the role of Chief Compliance Officer. You can find the Form ADV on the SEC’s website at www.adviserinfo.sec.gov. We continue to be gold acquirers, in this case hiring Mitch Golden to be co-PM of Greenlight Masters, our fund of funds. Mitch’s previous experience includes working in private equity at Oak Hill Capital, and as an analyst at both RH Capital and most recently at Senator Investment Group. Mitch earned an MBA from Wharton after undergraduate studies at Stanford University. Welcome Mitch! Emily Proctor has joined us as an Executive Assistant. Emily has a degree in Anthropology from BYU and an M.A. in Women’s Studies from George Washington University and shares her full name with a hiking trail in Vermont. The eponymous route runs for nearly 13 miles through the Breadloaf Wilderness, and is rated strenuous by multiple trail guides. For a shorter, easier hike, we suggest the David Einhorn Trail. Start at the pile of breadcrumbs in the kitchen and follow the trail of spilled coffee all the way to David’s office. Welcome Emily! Our long-time Office Manager Camille Granato is retiring. For those of you who have been with us since the early days, you might recall that Camille was once our entire operations and administrative team. With our current operations staff of sixteen, we can almost replicate Camille’s single-handed productivity and are reluctantly willing to let her retire. We wish her the best and will miss her dearly! At quarter end, the largest disclosed long positions in the Partnerships were Apple, General Motors, gold, Market Vectors Gold Miners and Microsoft. The Partnerships had an average exposure of 93% long and 53% short.
“The greatest enemy of knowledge is not ignorance; it is the illusion of knowledge.” --Stephen Hawking
Greenlight Capital, Inc.
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The information contained herein reflects the opinions and projections of Greenlight Capital, Inc. and its affiliates (collectively “Greenlight”) as of the date of publication, which are subject to change without notice at any time subsequent to the date of issue. Greenlight does not represent that any opinion or projection will be realized. All information provided is for informational purposes only and should not be deemed as investment advice or a recommendation to purchase or sell any specific security. While the information presented herein is believed to be reliable, no representation or warranty is made concerning the accuracy of any data presented. All trade names, trademarks, and service marks herein are the property of their respective owners who retain all proprietary rights over their use. This communication is confidential and may not be reproduced without prior written permission from Greenlight. Performance returns reflect the total returns, net of fees and expenses, for an IPO eligible partner. The 2011 returns for Greenlight Capital, L.P. and Greenlight Capital Qualified, L.P are net of the modified high-water mark incentive allocation of 10% and reflect the returns for partners who were invested on or prior to January 1, 2008. The 2011 returns for Greenlight Capital Offshore reflect our standard 20% incentive allocation. Performance returns for Greenlight Capital L.P. since inception reflect the total returns, net of fees and expenses, for an IPO eligible partner and are net of either the modified high-water mark incentive allocation of 10% or the standard 20% incentive allocation applied pursuant to the confidential offering memorandum on a monthly basis for a partner who invested at inception. Performance returns for 2011 are estimated pending the year-end audit. Past performance is not indicative of future results. Actual returns may differ from the returns presented. Reference to an index does not imply that the funds will achieve returns, volatility, or other results similar to the index. The total returns for the index do not reflect the deduction of any fees or expenses which would reduce returns. All exposure information excludes credit default swaps, gold, currency positions/hedges and other macro positions. Weightings, exposure, attribution and performance contribution information reflects estimates of the weighted average of Greenlight Capital, L.P., Greenlight Capital Qualified, L.P., and Greenlight Capital Offshore, and are the result of classifications and assumptions made in the sole judgment of Greenlight. Positions reflected in this letter do not represent all the positions held, purchased, or sold, and in the aggregate, the information may represent a small percentage of activity. The information presented is intended to provide insight into the noteworthy events, in the sole opinion of Greenlight, affecting the portfolio. THIS SHALL NOT CONSTITUTE AN OFFER TO SELL OR THE SOLICITATION OF AN OFFER TO BUY ANY INTERESTS IN ANY FUND MANAGED BY GREENLIGHT OR ANY OF ITS AFFILIATES. SUCH AN OFFER TO SELL OR SOLICITATION OF AN OFFER TO BUY INTERESTS MAY ONLY BE MADE PURSUANT TO DEFINITIVE SUBSCRIPTION DOCUMENTS BETWEEN A FUND AND AN INVESTOR.
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