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Netflix ($NFLX): Tilson Antes Up (Again)

October 26, 2011 | About:
Henry W. Schacht

Henry W. Schacht

13 followers
Whitney Tilson was very public about his short position in Netflix (NFLX). Come to think of it, is there anything that Tilson isn’t public about? Don’t get me wrong, I’ve always enjoyed his presentations, particularly when they agree with my investment stance. We all like validation.

In truth, I agreed with Tilson’s negative view of Netflix's valuation. Being short a few NFLX shares at the time added to the enthusiasm. When Tilson went public it was big news. How many Netflix skeptics were there? It took guts. Proving the point, several “friends” sent me emails with Tilson’s presentation attached. That was the one entitled Why We're Short Netflix. My favorite line: "In short, the stock is priced for perfection and any misstep would likely trigger a huge sell-off. "

Anyway, all the emails I got said roughly the same thing. “Hey look, here’s another idiot like you who thinks Netflix is overvalued. Don’t you morons get it? This time it’s different!” Okay. They didn't really say that, but it felt that way.

Now I’ve long been annoyed with Tilson (not that you care) for trying to make the term “value investing” his own private brand. Probably it is just jealousy that I didn’t think of the Value Investing Congress, the Value Investing Newsletter, etc., myself. But despite my view of Tilson as a great marketer, if not a great investor, I found myself on the same side of a trade with him for once. And, honestly, it felt good to be hand-in-hand in solidarity with Mr. Value Investing himself.

Besides, misery loves company. (Here we will pause for anyone who has not looked at a chart of Netflix heading to $300 a share or around $15 billion in market value.) And shorting NFLX was painful even for a chicken like me.

See, my short positions are normally not very big. I don’t short for clients, but instead limit my shorts to my (poor) children’s college fund. If things go wrong, I can take comfort in knowing that my children are too young to know what their father is doing to (I mean “for”) them. They think Daddy's job is boring and I don't want them to know how truly exciting (or terrifying) I sometimes can cause it to be!

So my Netflix short started small. It even came and went sometimes with a modest gain or loss depending on my mood. I felt very alone, lonely even. But as Netflix shares rose, I got more convinced and more serious about the thesis and my position grew. It soon got big enough that the kids might actually miss out on a semester or two if I was wrong. And for once, Whitney Tilson was my friend and partner, instead of the guy who stole value investing.

And then? Well, right about that time, Tilson deserted me! And not content to do so quietly, Tilson went public with “Why We Covered our Netflix Short” (as if anyone didn’t know). It should have said simply, "We've lost money and don't want to lose more," but instead the presentation argued that the facts about Netflix had changed. My favorite lines: "We conducted a survey," and "Many things will have to go very right for the company to justify its current market valuation, but we no longer think it’s wise to bet against Netflix."

In actuality the valuation on Netflix was only getting more pronounced and the competition was just getting warmed up. Tilson's Netflix reversal was about pain, more than it was about a letter from NFLX's CEO or any user surveys. The pain of watching a position go the wrong way has a way of making all counter-arguments seem more valid. The grass is greener on the other side and clients are pissed because you don't "get it"! So Tilson caved in. No more shorting Netflix, I promise!

Once again, I got emails. “See even Tilson has come around. You’re an idiot. Aren’t you tired of losing money too!?!?” And that obligatory attachment: http://valueinvestingletter.com/why-we-covered-our-netflix-short.html

In truth, I was tired of losing money. And I can’t prove I’m not an idiot. But shorting Netflix got easier for me as the price rose. Tilson's original short thesis on Netflix was well and truly intact to my mind. So my position grew again. Was it because I was mad at Tilson? Never.

Or because our family cancelled our Netflix account the day before the price increase? Yes.

Or because I got the feeling lots of other people were doing the same? You know it!

It also didn’t hurt that the company was trading at ever higher (and more ridiculous) valuations.

Even then it was not a worry-free investment. Seemingly every day there was a rumor that Netflix was going to be bought out. Google, Apple, the usual suspects. Certainly anything was possible. It pays to never underestimate a CEO who is desperate to “do a deal.”

Well, the phantom deal didn’t happen and Netflix is not riding high any more. It's been a swift drop from $300 to a more pedestrian value of $77 a share. The relief for me (and my oblivious children) and the small measure of redemption that comes with it is nice. The kids got their semesters back (and then some). But grad school will have to wait. I also closed my short in the low $100s, missing today's rout.

With Netflix's troubles in the news every day, I’ve thought about Tilson recently. He should be doing his victory lap. No doubt it would have a multimedia event that would dwarf my feeble effort!

It doesn’t make me feel good that Tilson missed this boat. We value guys need to stick together. But instead, Tilson is on the sidelines in a game he started. Every time I think about it the movie Rounders comes to mind. Yes, I know it is random.

In the movie, Matt Damon plays a poker player. Viewers follow his adventures in life and poker, often as they relate to Teddy KGB played by John Malkovich, who is an underworld character apparently of Russian descent (hence the name). In one sequence, Damon’s character plays KGB and earns enough to pay off all his debts (owed to KGB and payable in blood or treasure). Unfortunately, Damon's character plays on and predictably loses all his winnings. Not one to resist kicking a man when he's down, KGB gloats in a thick Russian accent, saying: “You must be kicking yourself for not walking out when you could… bad judgment… don’t you worry son, it will all be over soon.”

It doesn’t hurt that Tilson looks a bit like Damon. I wonder who will play Mr. Market in the Netflix movie?

In the final minutes of that Rounders movie Damon’s character finally takes down KGB, to which the Russian says in defeat, “He beat me… straight up… Pay him… pay dat man his money.”

Like any sap, I love a happy ending. After months of suffering and ridicule, I collected my Netflix winnings and moved on. I was hoping Tilson could move on too. One would expect him to avoid any mention of Netflix. Fool me once... fool me twice?

But apparently steering clear of Netflix is NOT in the cards for Tilson (pun intended). According to a headline today, Whitney Tilson Is Buying Netflix. The publicity machine rolls on.

Of his latest foray, Tilson writes:

“It’s been frustrating to see our original investment thesis validated, yet not profit from it. It certainly highlights the importance of getting the timing right and maintaining your conviction even when the market moves against you. The core of our short thesis was always Netflix’s high valuation. In light of the stock’s collapse, we now think it’s cheap and today established a small long position. We hope it gets cheaper so we can add to it.”
I admire Tilson's latest conviction on Netflix and I can't wait to read the presentation, which will no doubt be titled "Why We're Buying Netflix." In any case, I won't be following Tilson on this one. You might say I know when to walk away.

The real lesson here has nothing to do with Netflix, but about conviction. If you’ve done your homework, stick to your guns even if/when the going gets tough. Anyone can panic, and it usually happens at precisely the wrong time. In order to make real money in the market, more often than not you have to go against the crowd. My Netflix short looked wrong for a long time before I was proved right. If I'd relied on my emotions, I'd be looking at a fat loss.

Speaking of which, I've been short Amazon (AMZN) shares for quite some time. And I've been adding to the position steadily. If the after-hours move is any indication, it looks like the kids are going to get a few more classes paid for tomorrow. Grad school anyone?

Disclosure: Short Amazon

About the author:

Henry W. Schacht
Henry W. Schacht, CFA is the founder of Schacht Value Investors, an investment management firm serving individuals and institutions. He currently serves as President and Chief Investment Officer. He earned his MBA at the University Of Chicago Graduate School of Business and a BBA in finance from the University of Notre Dame. Mr. Schacht is a member of the Association for Investment Management & Research (AIMR), the Investment Analysts Society of Chicago (IASC), and the National Association of Corporate Directors (NACD).

Rating: 4.1/5 (15 votes)

Comments

dealraker
Dealraker - 3 years ago
Tilson, whether a decent investor or not and I have no opinion, has the media by the balls. He farts, they start sniffing.
LisaLL
LisaLL - 3 years ago


T2 Partners are very bright.

They made a ton on BP and GGP
cubsfan
Cubsfan premium member - 3 years ago
Shorting can be so difficult. If you have the discipline to take small positions, it can

work out, as you add on the way up. If positions are too large at inception, it's a killer mentally.
fareastwarriors
Fareastwarriors - 3 years ago


Tilson was right on the thesis but wrong on the timing. That must suck.
Koheleth
Koheleth - 3 years ago
Really enjoyed your post, even the references to investing for your children's education. I can relate to that.

I know it's not the main point you were trying to make, but I suppose many of us are also investing hard on behalf of our children.

I guess my point is simply that what may appear to be 'greed' to an uneducated observer is just ambition to secure the family's future.
hschacht
Hschacht - 3 years ago
Tilson was on CNBC today talking about how Hastings is a "real visionary". Proves that listening to management can be harmful to your financial health. I think a personal letter from Hastings was the final straw that caused Tilson to close his NFLX short... oops.
rabbit
Rabbit - 3 years ago


The jest of this article would have been meaningful 3 months ago. And congrats on your position.
hschacht
Hschacht - 3 years ago
I'm sorry that the article had no meaning. And thank you for the constructive criticism.
waup7707
Waup7707 - 3 years ago
With the possibility of unlimited loss, short is extremely difficult to execute. Buffett realized this early in his career and he pretty much stayed away from short. "The market can stay irrational longer than you can stay solvent." rings in my head when I have an impulse to short.
madbulk
Madbulk - 3 years ago
It had to be miserable being right and being stuck. I give the greater weight to his being right in the first place. It was a great call -- persuading me out of my long just before two years of straight up and 600% -- so it was brutal for me to watch -- but it was right and I knew it, and I also know I could NEVER have stayed short through that craziness. So he gets a pass, and congrats to you for holding out. :)
Amit Chokshi
Amit Chokshi - 3 years ago
Tilson will start offering VIC seminars from a hot dog stand on Park Ave/52nd...only $500 but you get his very own valuation analysis of Berkshire and a print out of the 13Fs of Greenlight and Pershing Square.
Adib Motiwala
Adib Motiwala - 3 years ago
Henry,

Good article and congrats on the successful short. It is an extremely difficult thing to pull off a short against an over valued, crowd loved, momentum stock that does not have feel gravity.!!

I think there are no points for getting the thesis right on a short and being wrong on the timing... the end result is that its the wrong call....especially if you close the short. You don't get any points for saying the thesis was right. Compared to that, if you are early in a long, you can hold on and be rewarded eventually.

Ill be honest. I was also short NFLX quite early in the 100s via Puts. I was trying to make small amounts via Puts. I got 2 trades right and one trade wrong. At the same time, I was short CRM via Puts. I got out of both positions with minor gains. I decided to focus my time and energy on the long side.

Btw, I have seen some excellent short thesis on SeekingAlpha. And it has nothing to do with valuation. It is all about the lack of cash flow (accounting for Payables), off balance sheet debt in the form of content deals, increasing cost etc. It is quite scary stuff. Shorts based primarily on valuation are disasters waiting to happen.

Adib

jcappo
Jcappo - 3 years ago
Good salesman like Whitney Tilson are usually susceptable to being easily sold themselves. When Tilson met with Reed Hastings, he allowed a presumably dynamic and charismatic entrepreneur and CEO to convince him he was wrong about his company, even though Tilson's original thesis about being short Netflix was spot-on.

I was also short Netflix when Tilson came out as a short and it was nice to have my opinion validated. However, I did not cover like Tilson did and not only endured the pain of having the short continue to go against me, but added to it on the way up.

The point in all this is not to say I was right, which I and many others turned out to be, but to caution investors about being short momentum stocks like Netflix. Even though Netflix had serious flaws in their business model for all to see, as long as they could generate both top line and subscriber growth, no one seemed to really care too much about the valuation, the extreme rise in content costs, and the coming onslaught of competition. All these things don't matter, until they do.

I think a better shorting strategy for high flying companies like NFLX (GMCR, LULU, AMZN, CRM, etc) is to start shorting them only after you see evidence that investor sentiment is starting to change and the stock price starts top break down. By doing this, you may not participate in the whole move down in the stock price, but you will save yourself the emotional grief and financial pain that comes with getting short the stock too early.
kfh227
Kfh227 premium member - 3 years ago
never shorted but when asked recently by someone thinking of buying Amazon, I bluntly told them no. 5 minutes of looking at financials is all it took. 3x overvalued?!?!? and a cronic share diluter . Who is buying it?Never shorted but AMZN looks like crap to me
Jonathan Poland
Jonathan Poland - 3 years ago
Jcappo is right about Tilson being a great salesman... will he recover from the 30% decline in his funds value this year will be the test of whether he's a good investor or not.
hschacht
Hschacht - 3 years ago
Some well thought out comments above, thanks. Amazon is a negative fcf generator for most of the year. Then in the 4th quarter they buy a bunch of product (and payables go way up)... those payables get paid off in the new year so fcf momentarily looks quite good. But because of the nature of the business fcf and net income at Amazon are going to be nearly identical over time. Only minor timing differences will alter it (for example 4Q vs 1Q).

But Amazon likes to tout these ridiculous fcf numbers and they also play games with fcf comparisons. Not illegal games, but games of presentation. Look at the most recent release and the talk about last 12 month fcf... they have do do that to include at least 1 4Q in the number.

Well, fcf at Amazon is going to be $2 billion or less (adjusted for payables)... and that is one heck of a valuation. But I'm thrilled that someone else mentioned the dilution issue at Amazon... sorta like Jeff Bezos cuts a hole in his shareholders pocket and little bits of ownership gradually trickle out.

As for the whole "unlimited loss" possibility, that is absurd... somebody mentioned that above. No stock is going to infinity and if it does, the brokerage firm will force you to cover long before infinity arrives.

But if you keep your short positions to a manageable size and you make gradual moves, it can be very rewarding even if (heaven forbid) valuation is your only guidepost.

Lastly, I am just amazed (after what has happened to Netflix) that this same group of investors (no, speculators) has not become a tad more circumspect about the valuations on their other favorites from VMWare to Salesforce and everything in between.
madbulk
Madbulk - 3 years ago
Not to put words in anyone's mouth, but valuation wasn't the only guidepost. That's just silly. And don't quote him back to me, of course it was valuation, but it's not valuation in a vacuum -- what would that even mean?

In addition to being a terrific self promoter, the guy is fairly brilliant and a hard worker. I don't know what his hedge fund is down this year, if indeed it's 30% then it's still merely up 200% over the past decade or so.

His thesis was right. The market was wrong and he was down a ton, it could've gone to 400 as easily and stupidly as it went to 300.

Howard Mark's is quoted in some recent anti-Tilson blog rant as saying something like, "If you're right but your timing is wrong, that's the same as being wrong." And if that's at all accurate, and I doubt it is, it's the dumbest thing he's ever said! The market can and will stay irrational longer than you can remain solvent. That still leaves you rational.

Tilson was right. And he'll be right again. Luck, as in lucky timing, is not something you can similarly count on.

Came out short Salesforce recently as well btw.

Adib Motiwala
Adib Motiwala - 3 years ago
Did Howard Mark write that towards Mr. Tilson ? I would like to read that...Can you share the link please ?

Btw, if you see Tilson's article on why he is now long NFLX, he clearly says that valuation was a major part of the short thesis ( which i dont agree since he made excellent points about the business, content costs, lack of good content etc)...
madbulk
Madbulk - 3 years ago
No no, Adib, I'm sure Marks' quote is from another context. I'm just saying that employed here, I wouldn't agree with it in the least. If I find it I'll post it back here. I'm sure it's in a reasonable context.

And on the other point, I maybe need to reiterate... I know Tilson is saying that he was short then on valuation and long now on valuation. And I'm saying, "DUH!" Any except the most technically driven is long and short on valuation. It's too expensive or it's too cheap. And he is saying it was too expensive and now it's too cheap. There's nothing here worth criticizing.

I totally agree with you and many... he originally made a great argument and I think it's still the prevailing one. He does not. So assuming he and I agree that it was valid to begin with, where must we diverge? Valuation! So that's how he expresses it.

His great call is still a great call. It just made a lot of people other than Whitney a lot of money and lost his investors a lot of money including me. But he was right and he'll be right again. More pitches coming over the next thirty good years.

Adib Motiwala
Adib Motiwala - 3 years ago
I have learnt some lessons regarding shorting. Shorting is difficult and shorting on valuation alone is a crazy thing to do at most times...So, if he was shorting mainly on valuation (which is what he is now saying...which i dont think was his argument when he wrote the short thesis), then you cannot say it was a great call. I also was bearish on NFLX in the low 100s and it went to 300...( I closed my puts) Was my call a good one? No way. It was pathetic. I was also short CRM at $100. And CRM even had EPS that was dropping... I am not sure when it will eventually fall... Its quite difficult to time it right. And in shorting, timing is very important. Unless, you can take the pain like Henry did! Everyone is not Henry. :)

Just imagine anyone shorting Dot com stocks in late 1999 and early 2000. You think they would have been able to survive...even if they were right? Ofcourse, it depends on how much exposure they had on the short side but still.....

Also, I would like to point out going long on valuation alone can be equally harmful to your health. Yes. studies exist which indicate basket of low P/E stocks do fine over time. However, if you are just picking an individual stock on valuation alone, it can hurt you just as bad as shorting on valuation.

My 2 paisa

Adib Motiwala
Adib Motiwala - 3 years ago
I know I posted this on another thread. But there are more people following this one... Its a great read

http://seekingalpha.com/article/302726-a-response-to-whitney-tilson-s-netflix-flip-flop
madbulk
Madbulk - 3 years ago
I think you make great points, Adib. I'll reconsider my position. For now I don't require that the stock market rewards my calls, the good ones are good and the bad ones bad. And I believe that over time the market will reward more than it punishes when the call is right -- else what are we doing? And when it doesn't, I gotta forgive it.

To me the call ended at, "Netflix is screwed and here's why and it shouldn't be more than 100 bucks." All of that made perfect sense to me. And still does.

His long thesis now doesn't make any sense to me at all because I expect all the numbers to continue to deteriorate over the coming years. My big variables disagree with his.

But I ain't shorting it even though it's going to 50. I don't short stocks. Perhaps that's why I'm forgiving him. The call "go short NFLX" was never heard by me. Only selectively heard one that said, "they're in trouble and if you're long, get out." Which I did. And now I'm vindicated! :) Thank goodness. That was painful.
cash9flow
Cash9flow - 3 years ago


T2 Partners holdings will be public in 2 weeks , so we can all peruse them to see if there was any movement . Also , his 3Q letter to his partners is already out , so if you can get a hold of it , it's always a good read

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