Read Online Fooling Some of the People All of the Time, a Long Short (And Now Complete) Story, Updated With New Epilogue by David Einhorn - Free Book Online Page B
Authors: David Einhorn
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cleared at the middle of the table and when the throne was in place, Wendt joined the meeting. After a lengthy pitch, Wendt took some questions. To any question that involved the numbers, Wendt had no answer. Over and over, his response was, “Someone will get back to you.” I had seen enough. We sold our bonds and added to our short.
Conseco issued a series of “turnaround memos.” These self-congratulatory tomes appeared designed to provide good news to juice the stock at random times. It seemed to work, and the shares doubled. However, each time Conseco reported quarterly earnings, there were more questions without answers. For example, in one quarter, corporate overhead magically turned to a corporate profit. How do you turn overhead into a profit ? No answer. The next quarter, the premiums and float fell in the insurance business, but capitalized customer acquisition costs and profit rose. How? No answer. Quite simply, the numbers did not add up, and Team Wendt was not interested in clarifying them. The stock continued to rise. Until it didn’t.
The next quarter, Conseco reported better-than-expected results. The results were, again, of low quality and raised many questions. The results were no worse than the previous batches. Nonetheless, this time the market did not buy it. The shares imploded. Eventually, Wendt resigned and the company went bankrupt. Subsequently, the company has reorganized, but is now much smaller. Its name lives on most conspicuously as the Indiana Pacers’ home court, the Conseco Fieldhouse. Some have observed that naming a sports arena is a good way to identify short-sale candidates.
Another troubled company with odd accounting was Orthodontic Centers of America (OCA), a rollup of orthodontist practices. The company accelerated revenue recognition and recorded more than all the profit from patients in the first months of a multiyear treatment cycle. As a result, toward the end of the treatment cycle, the average patient generated a reported loss. OCA had to rapidly grow the number of new patients to outnumber the old patients. Additionally, though OCA was 40–60 partners with the orthodontists, OCA back-loaded expenses by recognizing the orthodontists’ compensation expense on a “cash” basis rather than on an accrual basis. Based on our research, we discovered that OCA front-loaded revenues and back-loaded expenses to compound the impact of dual aggressive accounting practices on reported earnings.
For the second time, we outlined our concerns to the SEC. In March 2001, OCA announced that the SEC required it to change its revenue recognition to record patient revenues on a straight-line basis. The company delayed filing the annual report to restate results with 10 percent lower revenues and 25 percent lower profits than previously believed. Though the stock fell initially, the bulls believed OCA had put its accounting problems behind it. The restated results created easier future comparisons because OCA re-recognized the same revenues that it had improperly front-loaded and reversed in the restatement. By May, the shares recovered almost back to their previous highs. Partially changing the accounting, however, did not improve the overall bad economics of the business. By the following year, the cash flows badly lagged the earnings, and the shares collapsed. This created discontent among its orthodontists, who had bet their businesses on OCA stock. OCA eventually underwent a massive financial restatement and went bankrupt.
When the books closed in 2001, almost everything had worked. The fund returned 31.6 percent, and our assets under management reached $825 million. The bear market deepened, with the S&P 500 falling another 11 percent and the Nasdaq 20 percent.
Then, early in 2002, our two longest-standing and hardest-fought short sales finally paid off. As described above, after three years, Seitel finally imploded under the weight of its own bad business
Conseco issued a series of “turnaround memos.” These self-congratulatory tomes appeared designed to provide good news to juice the stock at random times. It seemed to work, and the shares doubled. However, each time Conseco reported quarterly earnings, there were more questions without answers. For example, in one quarter, corporate overhead magically turned to a corporate profit. How do you turn overhead into a profit ? No answer. The next quarter, the premiums and float fell in the insurance business, but capitalized customer acquisition costs and profit rose. How? No answer. Quite simply, the numbers did not add up, and Team Wendt was not interested in clarifying them. The stock continued to rise. Until it didn’t.
The next quarter, Conseco reported better-than-expected results. The results were, again, of low quality and raised many questions. The results were no worse than the previous batches. Nonetheless, this time the market did not buy it. The shares imploded. Eventually, Wendt resigned and the company went bankrupt. Subsequently, the company has reorganized, but is now much smaller. Its name lives on most conspicuously as the Indiana Pacers’ home court, the Conseco Fieldhouse. Some have observed that naming a sports arena is a good way to identify short-sale candidates.
Another troubled company with odd accounting was Orthodontic Centers of America (OCA), a rollup of orthodontist practices. The company accelerated revenue recognition and recorded more than all the profit from patients in the first months of a multiyear treatment cycle. As a result, toward the end of the treatment cycle, the average patient generated a reported loss. OCA had to rapidly grow the number of new patients to outnumber the old patients. Additionally, though OCA was 40–60 partners with the orthodontists, OCA back-loaded expenses by recognizing the orthodontists’ compensation expense on a “cash” basis rather than on an accrual basis. Based on our research, we discovered that OCA front-loaded revenues and back-loaded expenses to compound the impact of dual aggressive accounting practices on reported earnings.
For the second time, we outlined our concerns to the SEC. In March 2001, OCA announced that the SEC required it to change its revenue recognition to record patient revenues on a straight-line basis. The company delayed filing the annual report to restate results with 10 percent lower revenues and 25 percent lower profits than previously believed. Though the stock fell initially, the bulls believed OCA had put its accounting problems behind it. The restated results created easier future comparisons because OCA re-recognized the same revenues that it had improperly front-loaded and reversed in the restatement. By May, the shares recovered almost back to their previous highs. Partially changing the accounting, however, did not improve the overall bad economics of the business. By the following year, the cash flows badly lagged the earnings, and the shares collapsed. This created discontent among its orthodontists, who had bet their businesses on OCA stock. OCA eventually underwent a massive financial restatement and went bankrupt.
When the books closed in 2001, almost everything had worked. The fund returned 31.6 percent, and our assets under management reached $825 million. The bear market deepened, with the S&P 500 falling another 11 percent and the Nasdaq 20 percent.
Then, early in 2002, our two longest-standing and hardest-fought short sales finally paid off. As described above, after three years, Seitel finally imploded under the weight of its own bad business
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