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David Einhorn Says He's Short U.S. High Yield, Investment Grade Debt

David Einhorn Says He's Short U.S. High Yield, Investment Grade Debt

(Bloomberg) -- Hedge fund manager David Einhorn says that he’s shorting U.S. corporate debt as protections for creditors deteriorate.

His firm Greenlight Capital is wagering against both junk and investment grade debt, according to an investor letter seen by Bloomberg. The macro position will provide a hedge for the firm’s bullish equity positions in addition to being an attractive, standalone bet, the letter said. The cost of taking such a position is “quite low” as credit spreads tighten, according to the letter.

“Rating agencies have been complacent and allowed debt/Ebitda and debt/equity ratios to deteriorate without a corresponding reduction in credit ratings,” Einhorn said in the July 25 letter. “Meanwhile, we are a decade into an economic recovery and there are signs the economy may be slowing.”

David Einhorn Says He's Short U.S. High Yield, Investment Grade Debt

Credit graders have come under scrutiny by investors in recent years for letting companies load up on debt to fund acquisitions with minimal reductions to their credit ratings. A 2018 Bloomberg analysis of the merger boom found that more than half of companies making acquisitions pushed their debt ratios to levels typically associated with junk-rated companies but were allowed to keep investment-grade ranks.

Einhorn is joining several other prominent investors that have warned against froth in corporate debt. Credit market risk is at an all-time high, Pacific Investment Management Co.’s Scott Mather said in May and JPMorgan Asset Management’s Bob Michele recommended last month that investors sell the highs in corporate credit and buy government debt instead.

Companies including Anheuser-Busch InBev NV have now come under pressure from the ratings companies for failing to swiftly cut their debt loads after acquisitions. Years of easy-money policies from central banks have spurred companies to borrow cheaply in the debt markets and pushed the amount of debt rated in the BBB range -- the lowest investment-grade tier-- to $2.8 trillion, more than half the U.S. high-grade universe.

Despite signs that debt metrics have deteriorated, investors have continued to load up on corporate credit. Risk premiums on investment-grade bonds sit at just 1.09% over Treasuries, near the lowest levels since the financial crisis. An index of junk bonds hit an all-time high Thursday, and the notes have returned more than 10% this year, prompting some investors to warn it’s time to take profits. Corporate earnings are expected to soften and economic growth may slow, undermining the outlook for credit in the second half.

After losing 34% in 2018, the manager has rejiggered his portfolio to take fewer, more-concentrated bets. The main fund at Greenlight is up 18% for the year through June -- the best start to a year for his value-investing strategy since 2009. It’s a welcome vindication for Einhorn, who has seen his firm’s assets collapse from their $12 billion peak to about $2.5 billion toward the start of the year.

Other highlights from the letter:

  • In the second quarter, Greenlight started positions in chemical manufacturer Chemours Co., retailer Dillard’s Inc. and gaming equipment company Scientific Games Corp.
  • Chemours fluoroproducts business has high margins and favorable growth prospects and is worth more than the entire current value of the company, the letter said. Concerns over a bear case that Chemours has new liabilities related to firefighting foams are off base. Liabilities could run into the tens of millions of dollars, not billions of dollars as some claim, Greenlight said. This isn’t Greenlight’s first time investing in Chemours. The stock was its biggest winner between 2016 and 2017.
  • While many retailers are going out of business, Dillard’s six-quarter run of positive same store sales, low leverage and strong liquidity puts it in a better position
  • Scientific Games’s publicly listed online social gaming business, SciPlay Corp., has research and development expenses that are generally lower than its peers, while its margins are also higher than competitors. While consensus expectations are that SciPlay’s earnings per share will “grow at an annual rate of 23% through 2022, the shares trade at only 12x the 2020 estimate,” the letter said.

--With assistance from Joshua Fineman and Hema Parmar.

To contact the reporters on this story: Katia Porzecanski in New York at kporzecansk1@bloomberg.net;Claire Boston in New York at cboston6@bloomberg.net

To contact the editors responsible for this story: Alan Mirabella at amirabella@bloomberg.net, Nikolaj Gammeltoft, Josh Friedman

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