Short Seller Presses Bet Against Ratings Agencies (MCO, MHP)

David Einhorn of Greenlight Capital may do other things other than find companies to short sell.  But he became rather well known for his bet against Lehman Brothers even after it had already lost its prestige.  Many were covering their short-selling trades, but Einhorn kept his on and won handily for his insight.  But Einhorn’s less prominent short sale was in Moody’s Corp. (NYSE: MCO) because of his belief that the models of the ‘independent ratings agencies’ are going to permanently change.  And after last’s week’s court ruling that these ratings agencies are not immune against suits because of a protection under the First Amendment for freedom of speech, Einhorn has now started short selling McGraw-Hill Companies, Inc. (NYSE: MHP) as well because it is the owner of Standard & Poor’s.

In a CNBC interview this morning, after a Reuters article from last week, Einhorn laid out how this court ruling could be far worse for the companies than just a game-changing event to their business models.  He laid out the balance sheet scenario which sounds as though he is angling for what could be a corporate implosion from those firms.  Einhorn did not disclose just how much he is short in McGraw-Hill nor did he say how short he is in these.

What is interesting is that Harold McGraw, Chairman and CEO of McGraw-Hill, was presiding over the opening bell at the NYSE this morning.  It is with little doubt that this CEO is out meeting with floor traders and as many as he can right now to assure clients that their business is fine and that there are not going to be any significant changes for the company’s future.  That is of course conjecture, although it is a safe assumption considering that many who preside over an opening bell or closing bell have historically gotten access to many traders.

From everything we have read regarding this issue, it seems that the ruling was a mixed ruling, albeit very negatively mixed,  because many other issues were not against the ratings agency.  It should be no secret why Warren Buffett has started lightening up in his giant stake of Moody’s. Furthermore, you know that the ratings agencies are not going to not appeal and you know this is just another chapter of an unfinished book.  But this is a key ruling that could still go either way for the companies regardless of what officials at these companies and regardless of what others say.

On a side note as far as how this could affect each operation, Einhorn said that Moody’s Corp. had $300 million of cash and $900 million of debt.  Our look at the June 30 balance sheet shows about $397.6 million in cash and short-term investments and more than that in debt depending upon what you count as long-term debt.  In theory, McGraw Hill would be at least somewhat more insulated than Moody’s because at S&P there is also the Index business for the S&P 500 Index and a vast supply of other indexes and there is also the education business of McGraw-Hill and many other print and media operations there.  Its cash balance was $556.1 million at the end of last quarter.

The real wild card here is what will happen to forward earnings… Thomson Reuters has both companies forecast to profit in 2009 and 2010.  Estimates for 2009 and 2010 are $1.57 and $1.76 EPS for Moody’s and $2.25 and $2.55 EPS for McGraw-Hill.  Those figures do not account for a massive legal judgment and do not count for a sudden larger influx of suits that would increase the legal expenses drastically.

The McGraw-Hill Companies stock is around $28.00 today, and its 52-week trading range is $17.15 to $47.13. In early 2007 this was north of $60.00.  Moody’s is down under $24.00 and its 52-week trading range is $15.41 to $42.43. In early 2007 this was north of $70.00.

You get the idea here.  The risk bets are on for these, actually against these.

JON C. OGG
SEPTEMBER 8, 2009