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Allied Capital


took the unusual step of commenting on the drop in its share price Thursday after a hedge fund manager's skeptical conference presentation sent the stock into a tailspin.

Greenlight Capital co-president David Einhorn, who publicly disclosed that he is short Allied stock, knocked the company's valuation techniques Wednesday night and sent its shares down almost 11% to $23.20 Thursday.

Allied Capital is a "business development" firm with investments in more than 100 mostly private, middle-market companies. Among Einhorn's many criticisms was that the company has held investments in its telecommunications portfolio for too long before writing them down to fair value.

In a conference call, Allied's CEO William Walton, who was not present at Einhorn's speech, said the company "went through a rough period last year" and wrote down three big investments in Velocita, a partnership with




as well as Startec and NetTel.

"They said the issue is behind them," said Einhorn, who added to his existing short position Thursday. "But the fact is, this is characteristic of aggressive valuation techniques."

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In fact, Einhorn argued the issue isn't behind the company because Allied continues to value its Velocita holdings at a level that is well above fair value.

One of Einhorn's other concerns was the level of "payment-in-kind" income that the company receives when it provides mezzanine financing. If a company like Allied makes a loan and receives debt or securities instead of cash as interest or repaid principal, it's possible it would have to borrow money to pay its own dividend. If the company ran out of borrowing capacity, it could also be forced to issue equity, thus diluting ownership.

Still, Walton said the debt that is provided to the company in lieu of cash "allows us to increase the overall rate of return on the investment." In addition, he said the firm generated total cash flow of $180 million last year so "PIK income is not an issue in terms of meeting our cash requirements to pay the dividend."

Einhorn noted in his speech that the language of the firm's audit letter had recently changed, which he considers a red flag. The firm countered that the language is not dictated by its own auditors but by the AICPA. In 2001, the agency issued a new audit guide for investment companies, and because Allied falls into this category, the language was changed.

"We're really answering questions that we feel are completely unfair and unfounded," said Walton.

Einhorn also raised questions about the high interest rates that Allied charges its controlled portfolio companies Business Loan Express and The Hillman Group. Allied said it charges 25% and 18% for the subordinated debt, which it said is a typical rate.

Walton said both business are "ahead of budget" on both the revenue and EBITDA lines and look to be "real winners." But he added that Allied "will look at ways to break out more information so investors are more comfortable with those companies."

Allied also defended its purchases of discounted debt, saying that if a company chooses to sell debt at a discount in order to expedite the liquidation process, this provides good opportunities for the firm.

"Last quarter we purchased some sub debt at a discount and that was simply because of the fire-sale phenomenon and had nothing to do with the credit quality of the companies whose debt we were buying. In fact, it was a huge opportunity for us," said Walton.

While Banc of America Securities defended Allied on Thursday, calling the decline in price a great buying opportunity, Einhorn wasn't so impressed.

"I've sold more stock short today in response to their flaky answers," he said.