Posts tagged ‘T2 Partners’

Whitney the Netflix Waffler

Source: Photobucket

No, I am not talking about Meredith Whitney (see Cloudy Crystal Ball), but rather Whitney Tilson, a well-known value and hedge fund manager at T2 Partners LLC. Less than eight weeks ago, Tilson boldly and brashly exclaimed why Netflix Inc. (NFLX) was an “exceptional short” and provided reasons to the world on why Netflix was his largest short position (read Tilson’s previous post). Fifty-five days later, Mr. Tilson evidently was overtaken by a waffle craving and decided to throw in the towel by covering his Netflix short position.

What Changed in Seven and Half Weeks?

Margin Thesis Compromised: Tilson explains, “The company reported a very strong quarter that weakened key pillars of our investment thesis, especially as it relates to margins.” Really? Netflix has grown revenues for nine straight years since its IPO (Initial Public Offering) in 2002, and growth has even accelerated for two whole years (as Netflix has shifted to streaming content over snail-mail), and just in Q4 he became surprised by this multi-year trend? The Q4 growth caught Tilson off-guard, but I guess Tilson wasn’t surprised by the 7.5 million subscribers Netflix added in 2009 and first three quarters of 2010. Never mind the five consecutive years of operating margin expansion either (source: ADVFN), nor the stealthy share price move from $30 to around $225. Apparently Tilson needed the recently reported Q4 financial results to hit him over the head.

Survey Provides Earth-Shattering Results: Tilson conducted an exhaustive study of “more than 500 Netflix subscribers, that showed significantly higher satisfaction with and usage of Netflix’s streaming service than we anticipated.” Come on…Netflix has more than 20 million subscribers, and you are telling me that a questionnaire of 500 subscribers (0.0025%) is representative. Even if these results are a cornerstone of Tilson’s modified thesis, I wonder also why the survey wasn’t taken before Netflix became Tilson’s largest negative short position. In addition, I can’t say it’s much of a revelation that Tilson found “significantly higher satisfaction” among paying subscribers. That’s like me going to a Justin Bieber concert and polling J-Beeb fans whether they like his music – I’ll go out on a limb and say paying customers will generally have a positive bias in their responses.

Feedback Tilts the Scales: Tilson received a “great deal of feedback, including an open letter from Netflix’s CEO, Reed Hastings.” If I received a penny for every time I heard a CEO speak positively about their company, I would be retired on a private island drinking umbrella drinks all day. Honestly, what does Tilson expect Hastings to say, “You know Whitney, you really hit the nail on the head with your analysis…I think you’re right and you should short our stock.”

Some other inconsistencies I’m still trying to figure out in Tilson’s new waffle thesis:

Valuation Head Scratcher: Also frustrating in Tilson’s 180 degree switch is his apparent incongruous treatment of valuation. In his initial bearish piece, Tilson explains how outrageously priced Netflix share are at 63.1x the high 2010 consensus estimate, but somehow a current 75.0x multiple (~20% richer) is reason enough for Tilson to blow out his short.

Competition: Although Tilson went from 100% short Netflix to 0% short Netflix, there does not appear to be any new information regarding Netflix’s competitive dynamics from the Q4 financial release to change his view. Here is what he said in his article eight weeks ago:

“Netflix’s brand and number of customers pale in comparison to its new, direct competitors like Apple (iTunes), Google (GOOG) (YouTube), (AMZN) (Amazon Video on Demand), Disney (DIS) and News Corp. (NWS) (part ownership of Hulu), Time Warner (TWX, TWC) (cable, HBO, etc.), Comcast (CMCSA) (cable, NBC Universal, part ownership of Hulu), and Coinstar’s Redbox (CSTR) (30,000 kiosks renting DVDs for $1/night and email addresses for 21 million customers).”


Little is said in his short covering note, other than these negative dynamics still exist and help explain why he is not long the stock.

Gently Under the Bus

Whitney Tilson was “against Netflix before he was for it,” a stance that could generate a tear of pride from fellow waffler John Kerry. However, I want to gently place Mr. Tilson under the bus with all my comments because his sudden strange reversal shouldn’t be blown out of proportion with respect to his  full body of work. As a matter of fact, I have favorably profiled Tilson in several of my previous articles (read Tilson on BP  and Tilson on Fat Lady Housing).

One would think given my profitable long position in Netflix that I would be congratulating Tilson for covering his short, but I must admit that I feel a little naked with fewer contrarians rooting against me. The herd is occasionally right, but the largest returns are made by not following the herd. Short interest was about 33% of the float (shares outstanding available for trading) mid-last month, and with the recent melt-up, my guess is that short percentage has shrunk with other short covering doubters. I haven’t decided how much, if any, profits I plan to lock-in with my Netflix positions, but as Tilson points out, they are not giving Netflix away for free.

Credit should also be given to Tilson for having the thickness of skin to openly flog himself and admit failure in such an open forum. I have been known to enjoy a waffle or two in my day as well (more often in the privacy of my own kitchen), and waffling on stocks can be preferable to loving stocks to the grave. Tilson has proven firsthand that eating waffles can be very expensive and detrimental to your profit waistline. By doing more homework on your stock consumption, your waffle eating should be spread further apart, making this habit not only cheaper, but also better for your long-term investment health.

Wade W. Slome, CFA, CFP® 

Plan. Invest. Prosper.

DISCLOSURE: Sidoxia Capital Management (SCM) at the time of publishing had no direct position in DIS, NWS/Hulu, TWX, TWC, CMCSA, and CSTR but SCM and some of its clients own certain exchange traded funds, NFLX, AAPL, AMZN, AAPL, and GOOG, but  did not own any other security referenced in this article. No information accessed through the Investing Caffeine (IC) website constitutes investment, financial, legal, tax or other advice nor is to be relied on in making an investment or other decision. Please read disclosure language on IC “Contact” page.

February 14, 2011 at 3:18 am Leave a comment

BP: Sweet Opportunity or Sloppy Mess?

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Discussing the BP oil spill is not exactly cutting-edge, fresh news at this point. However, now that the 5 million barrel gaping gusher of black sludge has been plugged, many of the uncertain variables are beginning to come in focus. From mid-April this year, right before the disaster occurred, the equity value of BP’s stock peaked around $189 billion. The value of the company subsequently shed over $100 billion in value over the next two months, before rebounding to a level about -35% below the April highs today. BP is not out of the woods yet, even though the discussion has migrated from potential bankruptcy scenarios. The question now is whether purchasing BP stock currently is a sweet opportunity or just a sloppy mess that will drag value down for years to come?

Whitney Tilson, whom I profiled last year in Fat Lady Housing article, is the founder and Managing Partner of T2 Partners LLC who decided to tackle the tough BP questions. Tilson compiled his bullish thesis on BP at the 7th Annual Value Investor conference when BP’s share price was trading at $36.76. Why is Tilson so optimistic about BP’s stock price appreciation potential? He uses a few approaches, but his number one approach is a walk down catastrophe memory lane. If previous stock calamities resulted in opportunities due to investor overreaction, then certainly the same principal should apply to BP (or so Tilson believes). Here are some of the previous train wrecks Tilson highlighted in his presentation:

Pretty convincing evidence that the bark was bigger than the bite for these examples, but Tilson chose to save his best precedent illustration for last…Merck (MRK). In 2004, the pharmacy company came under assault after it was revealed the drug Vioxx increased the likelihood of patient heart attacks. What fanned the flames of panic were the allegations that Merck had known about these detrimental risks for years, but the company did not disclose this valuable knowledge. To make a long story short, the initial $50 billion liability estimate attributed to Merck actually came in closer to $5 billion and the stock rallied from a low of $26 in 2005 to $60 by the end of 2007. Tilson however, conveniently neglects to mention that the company’s stock shortly thereafter collapsed, before bottoming at $20 per share in early 2009 and settling in at a price around $35 today.

Regardless, Tilson’s points are well taken. Often these major catastrophes that sprawl across media headlines become overdone and offer an opportunity to those investors with thick skin and a stomach that can withstand severe heartburn.

Besides having history on his side, Tilson provided additional supportive bullet points to bolster his sanguine view on BP:

  • BP is a Cash Cow: The average estimate of BP’s liability (approximately $30 billion) is less than the $34 billion in operating profits ($20 billion in net income) expected to be realized by BP in 2010.
  • Financial Flexibility: BP has access to over $20 billion in access to cash and liquidity, not even counting the more than $100 billion in property, plant, & equipment (PP&E) on the balance sheet. Asset sales provide BP with even more flexibility.
  • Small U.S. Footprint: BP’s Gulf of Mexico operations, home of the Macondo well disaster, represent only about 15% of BP’s total global oil production, so the inference is BP would do just fine without access to the Gulf.

All, in all, Tilson provides a perspective with logical arguments to support his case. The analysis, however, does not give a lot of weight to political consequences that can cause this situation to go from bad to worse. Specifically, some pundits are using a more negative legal precedent of the tobacco companies to explain the downside potential of this situation (see legal pay-out table).

The 1998 master tobacco settlement agreement with the tobacco industry resulted in a whopping $206 billion in pay-outs to be made by the tobacco manufactures over 25 years (Financial Times). This is significantly greater than the $20 billion escrow account that BP has verbally committed to funding (and BP has already funded the account with a $3 billion initial deposit). What’s more, the spill volume estimates are a moving target, and as a result, BP just raised its oil spill cleanup costs from $3.95 billion to $6.1 billion. These numbers can have a way of becoming their own monsters over time.

As you can see, Whitney Tilson makes some pretty compelling arguments for BP, but not many arguments can be made against his long-term performance at the T2 Accredited Fund, which is up +202% since 1999 through mid-2010 (versus +7% for the S&P 500 for the same time period). If you believe Tilson, BP may turn out to be a sweeter kiss than the sloppy mess we constantly hear about.

Wade W. Slome, CFA, CFP®  

Plan. Invest. Prosper. 

*DISCLOSURE: Sidoxia Capital Management (SCM) and some of its clients own certain exchange traded funds, but at the time of publishing SCM had no direct position in BP, MRK, XOM,  or any security referenced in this article. No information accessed through the Investing Caffeine (IC) website constitutes investment, financial, legal, tax or other advice nor is to be relied on in making an investment or other decision. Please read disclosure language on IC “Contact” page.

August 11, 2010 at 12:52 am Leave a comment

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