Einhorn and Buffett Ready to Call Bets in Moody's Card Game: Street Whispers

NEW YORK ( TheStreet) - It might not be this quarter, but short-seller and professional poker player David Einhorn maintains ratings agency Moody's ( MCO) is poised for a big share fall as fraud allegations on its reviews of mortgage securities come to a head in 2013.

Einhorn -- who correctly predicted the demise of Lehman Brothers and recently set his gaze upon restaurant chain Chipotle Mexican Grill ( CMG) -- is sticking with the bet despite the fact that it's lost ground since being unveiled in the wake of the crisis and that he is facing off against bridge enthusiast Warren Buffett of Berkshire Hathaway ( BRK.A), who remains Moody's largest shareholder.

Buffett meanwhile has only pared his giant Moody's stake slightly since Einhorn conveyed his short bet and he's even defended the company in front congressional panels, to stinging criticism.

Now, with only one count remaining against Moody's and its competitor -- McGraw-Hill ( MHP) owned Standard & Poor's -- on a key lawsuit tied to pre-bust mortgage bond ratings, the score between Einhorn and Buffett is likely soon to be settled once and for all.

At the Value Investing Congress on Tuesday, Einhorn said so much, in a presentation that also outlined the investing logic behind other headline-grabbing investments such as short positions on Green Mountain Coffee Roasters ( GMCR) and Chipotle, and a conviction that election year politics are clouding an otherwise bright outlook for General Motors ( GM) and Cigna ( CI).

The contest between Einhorn and Buffett pits conflicting opinions on the extent to which Moody's and S&P can be held financially responsible for mortgage bond ratings that proved to be wildly inaccurate after the housing bust.

In September, a judicial ruling on lawsuits against Moody's and S&P's signal investors can continue to pursue fraud charges against the agencies, in litigation that casts doubt on whether ratings opinions can be protected by First Amendment free speech rights if a fraud can be proven.

After the ruling expunged all but a fraud charge against Moody's and S&P on a mortgage security it rated for Morgan Stanley ( MS), Einhorn said at the Congress on Tuesday that when the case comes to a head in early 2013, it could open a Pandora's Box of legal issues that would destroy their business model and finances of rating agencies.

"Its a matter of time before they all disappear," said Einhorn, of the rating agencies, in response to an audience question asking for an update on his short thesis.

The lawsuit, filed in 2008 by Abu Dhabi Commercial Bank and Washington's King County argues Moody's and S&P knowingly misrated a structured investment vehicle for Morgan Stanley, which the bank then sold off to unwitting investors who suffered losses shortly thereafter.

The SIV called Cheyne contained notes backed by supbrime mortgages and it received the "highest credit ratings ever given to capital notes," according to the judge presiding on the case. Those notes failed during the credit crunch, and plaintiffs argue the securities were knowingly misrated because of high fees paid by the issuer, Morgan Stanley, which is also a defendant in the case. Now they are litigating Moody's and S&P for fraud, in a last push to hold the agencies accountable.

Cutting against Einhorn's short bet on Moody's, many remain unconcerned about the lawsuit and are just one verdict away from having significant legal risk from the crisis removed. Buffett also appears highly confident. Since 2010, The 'Oracle of Omaha's' pared his stake in Moody's roughly 10%, but he remains the company's largest shareholder, owning nearly 13% of its shares as of June 30, according to filings with the Securities and Exchange Comission.

Year-to-date share gains in excess of 30% and a string of recent analyst upgrades for Moody's signal some are advising against Einhorn's bearish call and are siding with Buffett.

"While the Abu Dhabi case likely moves to trial in Feb. 2013, the company views the large number of favorable precedent decisions (and lack of "smoking gun" from extensive discovery) as strong indicators of a positive outcome," wrote Piper Jaffray analyst Peter Appert, in a Sept. 13 note to clients upgrading Moody's 2012 and 2013 earnings estimates. Strong debt markets and bond issuance amid record low interest rates are proving a tailwind for Moody's, added Appert.

"We are raising our 2012 revenue and EPS estimates, due to a surge in bond issuance, along with strong growth prospects at Moody's Analytics," wrote Benchmark analyst Edward Atorino, in a Sept. 17 note to clients that upgraded Moody's to a buy from hold and gave the agency a $51 a share price target. In the upgrade, Atorino didn't explicitly address pending litigation, which was only referenced as a boilerplate risk factor.

At the conference on Tuesday, Einhorn conceded in the near-term, his short position may continue to suffer a rebound in Moody's earnings. Still, he pointed to the Cheyne SIV trial to vindicate what's been a slow-burning short bet. Were fraud to be proven, other investors in securities rated by Moody's during 2007 and 2008 may chose to sue rating agencies before their rights expire, in a prospective explosion of legal liability stemming from the crisis, said Einhorn.

Both Einhorn and Buffett have sparred publicly on Moody's. In a June 2010 testimony to legislators, Buffett defended rating agencies, noting that Moody's shouldn't bare all of the blame for the crisis. "Look at me. I was wrong on it too," said Buffett about of the housing market, which he said greatest bubble he's ever seen. Buffett was excoriated in the press for his testimony, and in a Bloomberg TV interview, Einhorn subsequently pressed his short, questioning both the credibility of Buffett and the agencies.

Investors should watch for a February trial on fraud charges leveled against Moody's to settle the score between Buffett and Einhorn.

For more on Einhorn's presentation at the Congress, see why he's kicking the tires on GM.

See why Bill Ackman may have forgotten about his J.C. Penney and Procter & Gamble overhaul investments and why Jana Partners' Agrium breakup pitch is a shale oil and gas bet for other big investing ideas presented at the Value Investing Congress.

-- Written by Antoine Gara in New York

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