I'm a big Tilson fan. I wasn't always but he has grown on me. Why ? A few reasons:
- I think he is honest
- He admits mistakes
- He looks good on television
- He constantly refines his investing philosphy
- And he is good.... a decade of outperformance don't lie
In his recent letter to shareholders he had a very good section on mispriced options. The discussion was as result of recent investment he made that went bad. Here is the section:
Mispriced Options
LECG was a classic mispriced option, a type of investment that violates the rules of classic value investing, but with which we’ve had extraordinary success over time.
Warren Buffett is reported to have said that there are two fundamental rules of value investing: 1) Don’t lose money; 2) See Rule #1. We disagree. While it’s certainly true that investors should focus primarily on avoiding losses, we happily make investments in which we know there’s a decent chance – even a likelihood – that we’ll lose most or all of our money, as long as the upside is great enough to offset this risk. For example, if you could invest $100 in something that had a 70% chance of being worthless, but a 30% chance of being worth $1,000, would you invest? Of course, because the expected value is $300, or a 3x return.
But how much of your portfolio would you invest in this type of mispriced option, given that there’s a 70% of losing all of your money and looking (and feeling) like a fool? There’s no easy answer, but for us, in this situation, the answer is maybe 1% of our capital – and we’d look hard to find other similar investments so we could have a portfolio approach.
This is what we did, for instance, when we invested in the warrants of a handful of SPACs in late 2008 and early 2009 (and even created a side fund called the T2 SPAC Fund). By carefully selecting only a handful of the SPACs with the best sponsors and structure, we thought that each SPAC had a 50/50 chance of getting a deal done, in which case the warrants were almost certain to rise 5-10x. As it turns out, all but one SPAC got a deal done and we profited handsomely.
Outside of SPACs, other mispriced options that have worked out very well for us include our biggest winner ever, General Growth Properties shortly after it filed for bankruptcy, when the stock was around $1, TravelCenters of America, which rose 96.2% last month, Border’s bouncing from $1 to $3 in each of the past two years, and (many years ago) Denny’s.
But some percentage of these investments will be wipeouts like LECG, the Trian SPAC, and Sirva. That’s okay – it comes with the territory.
