- Various T2 funds are down between 1.8% and 2.3% for the year vs. up 4.9% for the S&P.
- Prior seven months has been the worst period of underperformance in the history of the fund. They haven’t lost money but have been left behind.
- What happened to create the underperformance? Were up 15% through August last year vs S&P down 4%, then basically went nowhere while stock market ripped up. Last August was nervous about sovereign debt issues, a double dip in housing and they increased their short book significantly. This has proved to be exactly the wrong thing to do at the wrong time. QE2 has unleashed animal spirits in the market and may well have done some economic good as well. Everything they made on the long side and then some was lost on the short side.
- Looking back they think they were way too enamored with making macro calls and shorting overvalued but good companies. Now they have cut their short book in half and no longer short companies based on valuation, but stick to shorting bad companies and frauds.
- Has been annoying and humbling experience. Key is to identify mistakes, acknowledge them and fix them.
- Current 12 largest long positions largest to smallest: Grupo Prisa (PRIS), Iridium (IRDM), Berkshire (BRK.A)(BRK.B), Microsoft (MSFT), JC Penney (JCP), Kraft (KFT), Seagate (STX), Fairfax, CIT Group (CIT), Anheuser Busch (BUD), BP (BP), General Growth Properties (GGP)
- Current 10 largest shorts alphabetical: Boyd Gaming (BYD), Ethan Allen (ETH), Basket of Homebuilders (HBS), for profit education, Gamestop (GME), Interoil (IOC), St. Joe (JOE), Salesforce.com (CRM), MBIA (MBI), Simon Properties (SPG)
- An emerging short theme is companies that will be hurt if inflation picks up
Question and Answer Session
- Talk about Grupo Prisa and Iridium – Grupo was part of a SPAC acquisition, they were merged into the Liberty Media SPAC. It had been an overleveraged company due to overpaying for assets. The banks were going to take over the business and merging with the Liberty vehicle was their only real option for deleveraging. Once the deal closed (T2 had owned the SPAC) T2 ended up getting both the A and B shares. They have eliminated all of the B shares as they believe the A shares should be at a $2 premium to them and aren’t. They think Grupo currently trades at a 30% discount to their peer group and a 30% discount to instrinsic value. They also think there is a lot of low hanging fruit in terms of improving operational performance. One concern is that the business has two thirds of its operations in the Spanish market which exposes them to the sovereign risk. T2 wouldn’t hold the company if the exposure was Greece or Portugal but think Spain is likely ok. They are ok holding a security in Euros without hedging and so far have benefited from that.
- Iridium is the satellite phone company, they own the network and companies they partner with are charged with developing products to use that network. Their service covers the 90% of the globe that wired cell phones can’t. Company history is to outperform their expectations and guidelines. They think that with future growth the company could trade at 3 or 4 times the current price. They are betting more on the long term growth story here than they typically do as value investors. Company has a unique capex profile where every 15 years or so they need to spend a few billion dollars to replace their satellites. This investment thesis is depending on growth for the company and there are plenty of smart people who don’t buy into the growth story. Very different risk/reward profile to something like Berkshire
- Why short Gamestop? They think the digital download move Gamestop is moving to will be their ultimate downfall. We have gone that route with music and books. We don’t need bookstores and record stores. Same will happen in the gaming industry. Believe that the inventory of used games that they have will prove to be very overvalued if the industry moves to digital downloading. Just can’t see how they manage to move from bricks and mortar fixed cost business to compete with companies who don’t have these costs.
- What is view on economy? Why short salesforce? Always try and remember that they aren’t macro prognosticators, think they can spot massive bubbles and busts but in between is difficult to predict. Every indicator they see is US economy getting better. Corporate profits are above where they were entering the recession. Housing market did double-dip as they expected and without huge support from the government it would be a massive double dip. Don’t know how much of the recovery is due to QE2 and what will happen when it ends. But big bets based on macro events is not what they want to do except in huge bubble scenarios. Salesforce.com is the one short they still have that is a good company with a high valuation, they just think the valuation is so extreme in this case that it can’t be ignored. Company had net income of $11 million, has a mkt cap of $19 billion. Guidance for 2011 is to make 8 cents per share which is down from 2010 which is down from 2009. They are growing the top line, but are unable to generate profits. The bull case is that they have huge growth opportunities and the money they make currently isn’t relevant. T2 doesn’t buy it. Thinks the company is in a very competitive sector that requires huge sales and marketing spending. Microsoft is making a push into the area with a product that is much less expensive. Microsoft can afford to not make any money to compete against them. Also the company gives it stock options like no company they have ever seen. Earnings are reported on a basis that excludes the stock option compensation. Stock at $135 per share with 10 cents of GAAP earnings guided for the forward year. In other words 1300 times this year earning estimate. Ridiculous expectations built into the stock price. Last time they checked this company had the second highest insider selling of any company in the States. Last year the CEO insider selling alone was more on a dollar basis than the GAAP earnings of the company.
- Berkshire Hathaway same old story, safe, cheap and growing at a nice rate
- On selling some General Growth holding, yes they have sold it down. Bought at $1, $4, $7 per share and now at $22 so it had become a mid-teens position. Catalyst of coming out of bankruptcy now gone and margin of safety not what it was. They are short Simon Properties and long General Growth. General Growth at a discount to Simon Properties and has room to improve operations as it was not well run prior to bankruptcy. They have concerns about inflation, which means they have concerns about interest rates, which if rising would pressure REIT valuations.
- Howard Hughes Corp is something they have been adding to. It is master plan community centers. Howard Hughes book value greatly understates actual market value of their assets. At $60 per share it has a lot of upside.
- Size of the funds currently $175mil plus $25mil in the Tilson mutual fund
- Regarding JC Penney – 25% owned by Pershing Square and Vornado and have reps on the board of directors. They find that stocks usually run up when big name investors take positions and if you wait you can usually catch it after the stock falls back. Pershing started in about $20, stock ran up to $35 and went back down under $30 when T2 got in. Thought it was trading about 4X EBITA. A good retailer trading at discount to 7x or 8x the comp group trades at. Interesting part about JC Penney is that they have a whole lot of miscellaneous assets that are embedded in the company but don’t generate cash but could be monetized. As an intellectual exercise you could imagine them spinning the real estate out in a REIT which would suggest that you are buying the retailer for nothing. This is not what is going to happen but does help you understand the valuation. But what is going to happen is that with Pershing and Vornado the capital allocation going forward will be optimal and the valuation is cheap. Think inflation is going to be a problem for apparel makers as the price of cotton increases. Very tough on low margin apparel makers especially.
- On BP, have exited most of the position. Believe it trades at a 25% discount to other big oil companies likely due to lawsuits involving joint ventures. No longer a high conviction investment. Noted that they actually owned some 3 month call options at one point last summer. At its peak after the well was capped BP was a 10% plus position. Generally they start selling a stock when it hits the low end of their intrinsic value estimate and finish selling when it hits the high end.
- Big picture on muni bonds and MBIA. Many states and cities facing financial distress, expect there will be losses to MBIA and other muni bond insurers. Lawsuit trying to unwind MBIA good bank and bad bank split, believe a 50/50 chance that is unwound which would be crushing to MBIA. T2 has long believed MBIA is a zero and are still short the company.
My comments — the more I listen to Tilson (and Glen) the more I like them. They are very rational thinkers, very honest with their comments. I’d have no problem handing them a good chunk of my net worth to manage. As far as their current holdings and ideas that I might pluck. I think their top two positions (Grupo and Iridium) are destined for my too-hard pile. I think Berkshire is a pretty good bet for slow steady gains, and the rest of the portfolio is pretty much big quality companies at decent valuations. I think it is a good time to be doing nothing as far as investing these days. Great bargains don’t seem plentiful. That could mean sitting on the sidelines for a couple of years, but at some point more obvious opportunities will knock.
The most interesting thing is that they now seem to be holding Fairfax Financial again. They mentioned inflation a few times, but Fairfax is positioned for deflation at this point so it might be a bit of a hedge.