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Kahn Brothers Vs. Einhorn: Which Value Investor Is Right on Assured Guaranty

Irving Kahn was one of the legendary value investors of the last century. When he finally retired at 109 (just before he died), Kahn had been investing for nearly 100 years. He saw some of the greatest market crashes in history, including the 1929 Wall Street crash. In the crash, he made a small fortune betting against Magma Copper, which he believed was egregiously overvalued.

After observing the carnage of 1929, Kahn built a strategy based on buying high-quality companies with strong balance sheets at low prices, avoiding leverage and living a modest lifestyle. He continued to develop this style while acting as a teaching assistant to Benjamin Graham in the 1930s.

Legacy lives on

Kahn died in 2015, but his legacy lives on through his investment firm, Kahn Brothers (Trades, Portfolio). Today, the firm is managed by his grandsons using the principles Kahn established over the past several decades.

Kahn might have passed four years ago, but the holdings of his firm today give some insight into the stocks he might be buying if he was still alive.

According to the investment managers' second-quarter 13-F filing with the Securities and Exchange Commission, which details investment holdings up to the end of June 2019, the largest holding in the Kahn portfolio was pharma group Merck & Co. (NYSE:MRK).

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Merck was just one of the holdings Kahn Brothers (Trades, Portfolio) added to substantially during the three months to the end of June. From just under 1 million shares at the end of the first quarter, the holding had risen to 10.7 million shares by the end of the second quarter, making up 11.2% of the investment portfolio.

The firm also bulked up its holding of global banking company Citigroup (NYSE:C). The investment managers increased the position by 20% to 1.1 million shares, and the holding makes up just under 9.7% of the overall equity portfolio (13-F filings exclude cash and credit investments).

The third-largest holding in the portfolio at the end of the second quarter was BP (NYSE:BP). Kahn Brothers (Trades, Portfolio) owned 1.7 million shares of the oil giant, a position worth just under $70 million at the time of the report.

The fourth-largest holding is the most interesting. This holding is life insurance group Assured Guaranty (NYSE:AGO). Kahn Brothers (Trades, Portfolio) owns 1.6 million shares worth $66 million. What is attention-grabbing about this holding is David Einhorn (Trades, Portfolio)'s Greenlight Capital is short the stock. While the shares look cheap on the outside, Einhorn said he believes Assured's "insurance book is in decline," and earnings are "expected to be less than $300 million this year."

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According to Einhorn's second-quarter letter to investors, the company's falling earnings are crimping Assured's ability to return cash to investors. "In prior years," the second-quarter letter to investors noted, "AGO obtained regulatory permission for special dividends -- generally in the order to $200 million to $300 million during the fourth quarter. This year, permission was granted approximately six months later than usual and it was for only $100 million."

The letter went on to speculate that based on these numbers, "It appears that the regulators are limiting AGO's buyback capacity." One of the reasons regulators might want to limit the company's buyback capacity is it has $4.5 billion of exposure to defaulted Puerto Rican debt.

Einhorn estimated that the company could be in line to lose as much as $3 billion from the restructuring of this debt. A loss of this magnitude would erode the company's capital buffers to a level at which regulators would likely restrict its ability to distribute earnings and repurchase shares, Einhorn concluded.

So, that's the bear case. I've not been able to find a bull case from Kahn Brothers (Trades, Portfolio) detailing why it believes the stock is undervalued, but it is still compelling to see opposing views from these two highly regarded value firms.

Disclosure: The author owns no share mentioned.

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This article first appeared on GuruFocus.