Whitney Tilson is a value investor who manages multiple hedge and mutual funds. He has co-authored multiple books including his latest, The Art of Value Investing. I recently sat down with Whitney to talk about election bets, the three worst words in investing and why the last few years have humbled him. Part II of our conversation follows in a video and transcript.
(Click here for part I of my interview with Whitney Tilson.)
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Forbes: One of your favorites is still Citi, even with the management change?
Tilson: Yes. Well, especially with the management change. I think the new CEO is excellent. If you want to look at where I think AIG can go, I think look at Citi, because I see very analogous situations. Enormously large, global financial companies, both of which basically went bankrupt, but on the verge of bankruptcy were bailed out by the government, both of which were massively complex businesses with lots of toxic loans and derivatives and so forth.
And both companies have been simplified, cleaned up, under new management, and I actually think these businesses are understandable today. A lot of people dismiss them as just too complex to understand. I actually think they are understandable and that I do understand them. So in the case of Citi, I was buying this stock at about half book. Book was about $50 a share. I was buying stock in the twenties. And today the stock is almost at book value, so it’s getting to the price at which, you know, I’m thinking about, is it time to exit and find my next fifty-cent dollar and ride it up to a dollar. I think AIG the stock has moved up. But I don’t think you’ve missed AIG, because it’s still trading at a healthy discount to book. And I think like Citi, it’s going to get there.
Forbes: Netflix.
Tilson: Yes.
Forbes: Been one of those talk about a romance or lack of romance. You’ve been on all sides of that?
Tilson: Yes. It’s one of a half dozen stocks in my entire 15 year investing career that I’ve been both long and short. And I have yet to find an investor who has a major position in Berkshire Hathaway and is enthusiastic about something as seemingly non-value oriented as Netflix.
Forbes: Well, as you know, the stock as done sensationally. You’ve done very well with it.
Tilson: Yes. After years of purgatory, the stock went from $10 to $300, then down to $50, and now it’s up to well over $200.
Forbes: So is this one of the those « I missed it » traps?
Tilson: It’s hard for me. I think if ever in my career I’ve never had a stock quadruple in seven months. And it’s been a rocket ship, and I’ve been happy to ride it. But I believe been taking money off as it’s risen because it’s very difficult to value Netflix.
I can tell you what Berkshire Hathaway is worth, plus or minus 10% with high degree of confidence. With the same degree of confidence, I couldn’t tell you plus or minus 50% on Netflix, because it’s a very open-ended situation. I think in ten years, I think it has the possibility of being an enormously valuable media company that could have a market cap like Amazon’s or something of $100 billion.
Today it’s at $13 billion, right? So I think it has that kind of upside, but it also has a lot of big competitors, has a lot of execution risk. And so with the stock having quadrupled, I’m still holding onto a 3% to 4% position, but AIG is an 11% or 12% position, Berkshire is a 9% or 10% position, to give you a sense of the relative position sizes.
Forbes: Japan.
Tilson: Yes.
Forbes: You’re bullish on Japan?
Tilson: No. I’m bearish in Japan. I’ll give full credit to another hedge fund manager named Kyle Bass of Hayman Capital who made his name predicting the collapse of the subprime housing market here in the United States. He has been quite bearish on Japan for years.
This has been a popular trade on Wall Street, betting that Japan would encounter problems with its debt, that the yen would weaken. In fact, the trade has a name on Wall Street. It’s called widow maker because everyone who’s ever put on this trade has lost all of their money because Japan has been remarkably resilient. The yen stayed strong, interest rates stayed super low, but just in the past few months under Abenomics, the new prime minister there, he seems quite determined to print a lot of money, which is weakening the yen. So the yen has had a very sharp weakening, which is actually good for Japan, and it’s good for the bet that Kyle Bass and I have made.
What’s interesting is to see what happens to interest rates there because Japan has benefited from ultra, ultra-low interest rates. Much lower than the United States treasury rate, for example about half the U.S. rates, despite the fact that Japan’s debt to GDP is well over 200%. So Japan’s budgetary situation, I would argue, is alarming. And there could be a real train wreck there if the investors of the world start to question Japan’s credit and interest rates start to spike up.
Because even with ten-year Japan JGB rates well under 1%, the interest on Japan’s debt, because their debt is so large, is a huge portion of their annual spend. And if interest rates double from half of 1% to 1%, that would still be a very low interest rate, but that puts the government on the verge of bankruptcy, I would argue.
So interest rates have been shooting up just in the past day or two, in fact. The NIKKEI was down 7% yesterday. For the sake of the world, I hope the world’s largest economy doesn’t hit the windshields. But a friend of mine has called Japan a bug in search of a windshield. And that bug may be hitting the windshield right now, and that could have very interesting consequences for the rest of the world.
Forbes: Do we have a bond bubble here?
Tilson: I would argue we have an 80% of what there was back in ’06, ’07. So it’s not as extreme. Underwriting standards haven’t completely gone out the window. There isn’t the degree of fraud that there was back then, but the interest rates investors are willing to accept and in particular I see it on the stock side where any stock that’s offering some big fat dividend investors pile into almost no matter how risky those cash flows are and how risky that dividend is.
I’m seeing elements of a bubble, certainly, at the periphery. It’s always been puzzling. I think one of the reasons stocks are doing well blue chip stocks, the S&P 500 is hitting new highs is because the S&P 500 stocks are yielding an average of 2.5% or 3%. In a world of tenure treasuries well under 2%, a blue chip, dividend-paying stock that you can buy at 12 or 13 times earnings that pays you a nice 3% dividend is dramatically more attractive than a ten-year treasury. I think the institutional investors of the world are starting to figure that out, and they’re bidding the prices of stocks up in response to no yield on debt.
Forbes: Unusual stock in your portfolio: Spark Networks.
Tilson: Spark Networks, yes. It’s a very small company, and it runs online dating sites. The one it’s best known for is JDate for Jewish singles. And for the past 11 years, they’ve dominated that niche, and it’s a very small niche. They generate about $26 million a year of revenue from JDate. But it’s a beautiful cash cow. They have 90-plus percent contribution margins, and they don’t really have to reinvest in it very much. And it has very attractive economic characteristics. So a few years ago, they said, « We have this expertise running niche dating sites. So what should we do? »
And they identified the Christian market. There are 30 times more Christians than there are Jews in the United States, so they created a website called Christian Mingle. And they poured a lot of money in it to just basically create JDate for that market. Last quarter they grew revenues 45% year-over-year.
And JDate as I mentioned has about $26 million of annual revenues. It’s been flat for ten years. Christian Mingle is running at a run-rate of $40 million of revenues and growing 45% a year. So the stock it’s another one of those « I missed it » stocks where the stock has gone from $3 and change to $7 and change over the past year.
But I think it could be a Netflix kind of situation. It has very open-ended characteristics, very rapid growth, and the online dating business has actually gone mainstream. It’s no longer a seedy or disruptive thing. So I think there’s a very nice tailwind.
And frankly, I think Barry Diller buys Spark Networks. Spark Networks has less than a $200 million market cap, so it would be a little bite-sized acquisition. And they could just add it into Match.com. And Barry Diller loves the online dating business. He loves Match.com, so this would be a nice little acquisition for him. So that’s another way you win.
Forbes: You’re going to bite out of Apple?
Tilson: Are asking do I own Apple stock? I do. I got back into it just before they reported earnings a few weeks ago, a little under $400 a share. Added a little more after earnings. My feeling about Apple is: I’m not sure what to think about it long term, but I think it’s likely to do well in the next six months or so simply because I think they’re in a new product launch.
They haven’t announced any new products in a while, and that’s caused investors in a very short-term way, I think, to think of Apple as a company with no more innovation now that Steve Jobs has passed. It’s quite certain that there’s going to be a new iPhone 5S coming out. They’re going to come out with a new iPad, and iPad mini with a retina display.
I know they’re working on some big product. There’s lots of big orders at the suppliers in Asia. But no one is quite sure what the big new product is. It could be an iPhone with a bigger screen, which is a market that Samsung has had to itself and some of Apple’s competitors. I think that’s a no-brainer for them to go. It could also be a lower-end iPhone to try and take that market as well, which I think would make sense for Apple.
So I think there’s likely to be some product innovation announcements in the next three to six months that I think will change investors’ sentiment, which is highly negative toward Apple. I think the stock goes from $400 to $500, maybe $550 over the next three to six months.
At that point I’ll have to decide do I want to stick around? Do I believe that Apple is really going to be an innovation engine like they’ve been in the past? Or do I just take my 25% to 35% profits and move on? I don’t see a lot of downside. They’re paying a nice dividend. They’re just under pressure from David Einhorn. They’re buying back a lot of stock. So I see minimal downside and some decent upside.
Forbes: What have you learned from JC Penney?
Tilson: Well, one of Buffett’s favorite sayings is, « When a management team with a reputation for brilliance encounters a business with a reputation for mediocrity, it’s the reputation of the business that remains intact. » Right? It’s easy to second guess Ron Johnson after the fact, but he was the perfect retail CEO.
I got very enthusiastic about him and his plans and got blinded. This is a good example of how emotions can overcome logic, and I got blinded by his star power and his résumé and about the he could work on what is a very difficult project to turn around a 100-year-old business with $17 billion in sales and very entrenched customers it’s had for a long time.
It’s very difficult to draw new customers into that kind of environment. And Ron Johnson’s strategy was a complete disaster, and it was disconnected from the reality of JC Penney’s customer and business. And I eventually figured that out and got out in the mid-twenties. And the stock went down into the $13 range at one point.
I actually am back in it just in the past month or so. Once Ron Johnson left and once they raised some capital, which they just finalized yesterday $2.25 billion of capital where they basically borrowed against their real estate and other assets. And I think that buys them time.
They’re basically just going to undo the things that Ron Johnson did. And so the real question is can they earn back the sales? Can they bring back the customers? Had you designed a strategy to drive away as much of JC Penney’s core customers as possible, as quickly as possible, it was Ron Johnson’s strategy. And that’s what they did.
But this is not some fly-by-night teen retailer chasing some fad, where once the sales go down, you can put a fork in it. It’s going to go bankrupt, right? This is a company that’s been around for a hundred years.
I commissioned a national survey of JC Penney customers and asked them, « If things went back to the way they were before, would you come back? » And the majority of them said, « Yes. » So I think JC Penney it’s not going to be easy, but I think the negative expectations built into the stock that any kind of stabilization, much less any indication that customers are coming back, I think the stock is a quick ride into the mid-$20s. And then again, then I’ll have to decide if I believe in the long-term turnaround or not.
Forbes: Quickly, short sales. Very, very tough to do.
Tilson: I was talking to a very experienced short seller last night, and I’ve been doing this a while myself. And we both agreed that the carnage of anyone shorting anything this year on the U.S. market is something we haven’t seen since 1999, 2000. You look at any stock with high short interests, the most speculative high flyers, the diciest business models, the most over-levered companies those are the stocks that have ripped up the most.
It’s very clear to me, anyway, that there are humans and computers now just scouring, and they’re playing the squeeze-the-shorts game. A lot of folks who are short haven’t experienced this kind of those, and they can’t take the pain. So they’re panicking and covering, which means buying the stock, which is adding further fuel to these stocks riding up.
Fortunately I’ve got my Netflix going parabolic in my long book, and my whole long book is doing fabulously well. So I’m having a decent year this year, despite the fact my short book has been a carnage. It’s the only word I can use to describe it. But you know what? It’s now gotten to be on principle; I am not covering a single share. As long as I think I’m right on the company, and if I think a stock is worth $10, and I short it at $35, and now it’s at $90, I don’t care. I am not covering it. I think it’s just a much better short at $90. And when I read newspaper articles about day traders from their home playing this squeeze-the-shorts game and piling into these momentum stocks, I’ve seen this before. I know how it ends. I can’t tell you how quickly it happens, but I know how it ends. And I will take the pain.
Because, look, if you’re going to short stocks, by the way, I don’t recommend the average person short stocks. We’re getting a good lesson in why right now. You’ve got to have just an iron constitution, be willing to suffer volatility, be willing to have people shooting against you. But it can still be a very profitable business. Eventually the stock market is a weighing machine, but in the short term, it’s a voting machine.
Forbes: What are some of the ones that you believe most in?
Tilson: You know, I’m almost hesitant to talk about them, partly because they’re very crowded shorts, and that’s one of the dangers of being on the short side. If everybody piles into the same shorts, you get these horrible short squeezes. One of my largish shorts that’s been a good lesson in how hard shorting is, because it’s near all-time highs today, is the little company called Interroyal.
It’s not so little anymore. It’s about a $4 billion market cap company that has people of questionable reputations and background who claim to have discovered the world’s largest natural gas field in Papua New Guinea, of all places. And they’ve been there drilling wells for 15 years.
Every time they drill a well, some natural gas comes up, and they light it on fire and they take a picture and they claim to have found the world’s biggest natural gas field. And they actually pay a consulting firm to come in and say, « Well, if what management says is true, then indeed they have found the world’s natural gas field, » the key caveat being is « what management says. »
So very, very questionable, and for years they have been saying that they’re going to partner up with Shell or one of the big oil companies of the world to develop this field that they’ve found. And every year, every quarter like clockwork for year after year after year, they’ve been, « We’re just on the verge of announcing some big deal, and the stocks going to go nuts. » And investors continue to believe it even though the promised deadline just keeps coming and keeps passing and nothing happens.
I’ve been short this stock for the better part of five years. I know this company very, very well. They have not delivered on a single promise that they’ve made over these five years that I can recall. This is a great example of the environment that we’re in. The stock this year has gone from $50 to well over $90 a share.
So it’s almost doubled on promises that they’re on the verge of announcing a major deal. How many times does Lucy have to pull away the football before Charlie Brown stops trying to kick it and ending up on his back? So that’s the kind of environment that we’re in. It’s probably a good example of one of the most extreme promotions I’ve ever seen, but in the meantime, you can’t get any stock to borrow. So all the smart guys have already shorted this and are just waiting for it to crack. But in the meantime, the stock just rips up. Shorts are getting squeezed.
The folks on the message boards are proclaiming that this is the greatest thing, and it’s still cheap. And it’s going to double, and they’re going do a deal with Shell. And I don’t believe any of it. I think intrinsic value here is zero. There will be no recovery for the equity on this eventually.
Forbes: Finally, what’s the best money advice you ever got?
Tilson: I would say Warren Buffett, years and years ago (he’s repeated this many times when he meets with students) has always said, « The best way to think about investing is you’re coming out of business school or you’re coming out of college now. And you have a card, and it has 20 punches. And every time you make one investment, you have to punch that card, and that’s all you get for your whole life. Not for the month, not for the year. That’s your life. You can make 20 investments. » And it’s ironic, because if you study Buffett early in his career, he said, « I would buy stocks trading at two times earnings, and then they’d run up 50% and trade at three times earnings. And I would sell them to buy more stocks trading at the world times earnings. » That was back when he was running a small Buffett partnership. So in other words Buffett has owned thousands of stocks over his career. But the principle is a good one.
Which is investing is very, very hard. Finding the occasional mispriced situation where you’re right and the market is wrong very wrong, not a little wrong, very wrong is very difficult and ultimately quite rare. And therefore you should have an extremely high bar before taking your hard-earned money out of your bank account and putting it into something that could be very risky. A stock is risky.
So you don’t want to take that risk unless it’s a slam dunk, unless the odds aren’t 60-40 in your favor. The odds are 95-5 in your favor. And that’s the kind of discipline and patience you have to exercise and so the 20-punch-card analogy is a pretty good one. If you could only make 20 investments in your lifetime, you would think very long and hard and do extra research and have a really high bar before making an investment. So it’s a good principle to follow.
Forbes: Whitney, thank you very much.
Tilson: My pleasure.
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Steve Forbes is the co-author of Freedom Manifesto: Why Free Markets Are Moral And Big Government Isn’t.
