Whitney Tilson is the founder and Managing Partner of T2 Partners LLC and the Tilson Mutual Funds. The former (http://www.T2PartnersLLC.com) manages three value-oriented private investment partnerships, T2 Accredited Fund, Tilson Offshore Fund and T2 Qualified Fund, while the latter is comprised of two value-based mutual funds, Tilson Focus Fund and Tilson Dividend Fund (www.tilsonmutualfunds.com).
Mr. Tilson is also the co-founder, Chairman and co-Editor-in-Chief of Value Investor Insight(www.valueinvestorinsight.com), an investment newsletter, and is the co-founder and Chairman of the Value Investing Congress (www.valueinvestingcongress.com), a biannual investment conference in New York City and Los Angeles.
Mr. Tilson writes a regular column on value investing for the Financial Times and Kiplinger's, has written for the Motley Fool and TheStreet.com, was one of the authors of Poor Charlie's Almanack, the definitive book on Berkshire Hathaway Vice Chairman Charlie Munger, and teaches financial statement analysis and business valuation for the Dickie Group. He was one of five investors included in SmartMoney’s Power 30, was named by Institutional Investor as one of 20 Rising Stars, has appeared many times on CNBC, Bloomberg TV, Fox Business Network, Lou Dobbs Moneyline and Wall $treet Week, was on the cover of the July 2007 Kiplinger’s, has been profiled by the Wall Street Journal and the Washington Post, and has spoken widely on value investing and behavioral finance. He served on the Board of Directors of Cutter & Buck, a public company that designs and markets upscale sportswear for two years until the company was sold in early 2007.
Prior to launching his investment career in 1999, Mr. Tilson spent five years working with Harvard Business School Professor Michael E. Porter studying the competitiveness of inner cities and inner-city-based companies nationwide. He and Professor Porter founded the Initiative for a Competitive Inner City, of which Mr. Tilson was Executive Director. Mr. Tilson also led the effort to create ICV Partners, a national for-profit private equity fund focused on minority-owned and inner-city businesses that has raised nearly $500 million.
Before business school, Mr. Tilson was a founding member of Teach for America, the national teacher corps, and then spent two years as a consultant at The Boston Consulting Group.
Mr. Tilson received an MBA with High Distinction from the Harvard Business School, where he was elected a Baker Scholar (top 5% of class), and graduated magna cum laude from Harvard College, with a bachelor’s degree in Government.
Mr. Tilson’s parents are both educators and he spent much of his childhood in Tanzania and Nicaragua. Consequently, Mr. Tilson is involved with a number of charities focused on education reform and Africa. For his philanthropic work, he received the 2008 John C. Whitehead Social Enterprise Award from the Harvard Business School Club of Greater New York. He is also a member of the Young Presidents’ Organization. Mr. Tilson lives in Manhattan with his wife and three daughters.
Whitney Tilson was kind enough to devote several hours of his time to let me interview him. I asked him a variety of questions including value investment philosophy, specific stock holdings, and his opinion on the housing market and the economy.
Our conversation is below (note that this is not an exact transcript, but rather my notes from our conversation):
This is usually the first question I ask value investors. Value investing is contrary to human nature. Every value investor has a story how they got started in value investing. What was your catalyst?
I came late to investing. I was very interested in business and attended Harvard Business School. I would read the Wall Street Journal and immediately throw away the section on investing because I had no interest in it.
After college I had no money and I was in debt and after that I went to business school and had business school debt. My parents are teachers and I didn’t grow up with any money. Money is the necessity of invention so in 1995 I had my first $10,000 in my bank in my life. Bill Ackman who I went to college with was still at his original hedge fund Gotham Partners, and he was the only guy I knew in the investment business. He said there was only one thing I needed to do: read all of Warren Buffett’s letters, and that was the best advice anyone has ever given to me. Intuitively it made a lot of sense; just buy a dollar bill for fifty cents.
I read avidly all of Warren Buffett’s letters, and all the books about him, and I read Peter Lynch’s books, and other books about investing, especially value investing.
I started practicing with my own tiny portfolio. In the late 90s I was a classic late 90s bull market genius: I bought high quality businesses like Microsoft, Dell, Home Depot, a little bit of Gap. These were business I thought I could buy and hold forever, I was very naïve.
It was fun and I thought I was God’s gift to investing. In hindsight it was very naïve and I was clueless. After a few years I decided that I wanted to make a business out of my hobby.
I started on Jan 1st 1999, I had three investors: myself, my in-laws and my parents with about $1 million dollars. I managed it out of my bedroom. I had no costs and my wife was a lawyer with a good paying job so she paid the bills and I worked very hard out of our apartment managing the world’s smallest hedge fund. At that point I was still riding my “Nifty fifty” stocks that I had bought four years earlier, and I also owned some Berkshire Hathaway at the time.
I heard Warren Buffett predicting a bubble and I got nervous about it too. I got a job writing articles for the Motley Fool in late 1999 so I have a paper trail where you could read some articles where I talk about the bubble. I started writing there in September and I became a regular contributor in November 1999.
I was preaching the gospel of Buffett, and telling people not to get fooled by the bubble.
I turned out to be right, though I mistakenly thought blue chips like MSFT were good buys. I was wrong in some ways but in the big picture I was right.
I read a lot and learned very fast. I sold enough of the Nifty fifty stocks and bought enough of the value stocks to survive the crash from March 2000- October 2002.
I do not recommend that to young people that they start as I did with virtually no experience in the business. I recommend to many people who write to me, don’t do as I did; instead, go work for someone and learn the business. I was lucky -- in hindsight, I had no business going into this business.
You mention Bill Ackman as your original mentor. Do you subscribe to his philosophy of investing? You mentioned Warren Buffett as your mentor also. There are many different styles in value investing ranging from Benjamin Graham's net-nets to Warren Buffett's purchase of companies with wide moats? What style do you must subscribe to?
We draw from every different style. Value investing is simply buying a stock at a significant discount to its intrinsic value. The closest classic value stock we own which is almost a net net is a small retailer named Delias which is trading close to cash. We also own Berkshire Hathaway which has $186 billion market cap which is more of a growth at a reasonable price. We also own General Growth Properties; the company is in bankruptcy which I would classify as a special situation. We try to find lots of different value opportunities and we try to keep an open mind.
On a similar note Graham held stock short, so did Schloss. The biggest jump made by Buffett was really caring about the quality of the businesses he invests in. Benjamin Graham was mostly quantitative not qualitative. Phillip Fisher and Charlie Munger made Buffett see out in the future and what is called looking through the numbers. Have you adopted the same approach in you look through the numbers?
Benjamin Graham’s core investment approach was buying statistically extremely cheap stocks. Walter Schloss and more recently Paul Sonkin of Hummingbird Capital are a good example of that fundamental approach.
Buffett in his early career made his fortune buying extremely low-quality business like Berkshire Hathaway, which was a dying textile business, at extremely low multiples of cash flow and/or discounts to liquidation value, so called net nets. Berkshire was in fact a net net when Buffett bought it. He once joked that in the 1950s or 1960s he would buy companies at 2x earnings and sell them at 3x earning and make a 50% profit. He would then find another business selling at 2x earnings and buy it.
Thanks slightly to Phillip Fischer but mostly to Charlie Munger and due to his own learning -- Buffett is a learning machine -- Buffett began to appreciate higher quality businesses and businesses that could grow value over time and how valuable those valuable could be. In my opinion, See’s Candies is the first example of a business in his career where he paid up for a high-quality business with a brand and moat and Charlie Munger helped him see that value and pay a higher price then he normally would have paid.
The problem with being an investor in net net stocks is that they are very small and illiquid. Buffett knew that to grow his wealth he would have to cast a wider net to put more capital to work.
It sounds like you think that Warren Buffett changed his business style due to the forces of circumstances. Do you think Warren Buffett would be a Net-net investor if he was much managing less cash?
Yes, that is absolutely true. He has been asked this question many times and responded that if he were to be managing very little money he would be looking in the nooks and crannies looking for extreme temporary mispricings. If you know where to look, you can sometimes find extreme temporarily mispriced stocks. However these stocks are usually small and it is hard to put much money into them. Not in a million years would Buffett own Kraft if he was managing $10 million.
Considering that the world today is different from the time of Graham and Dodd where more attention has to be focused on owner's earnings and cash flow, what do you suggest as the best resource for learning financial statement analysis including proper statement adjustments from a value perspective?
I do not have a good answer for this. I am self taught and have just done a lot of reading. There are a lot of good books. Thorton O’Glove wrote Quality of Earnings on finding red flags in earnings. Howard Schilit wrote Financial Shenanigans. Tim Koller wrote a book called Valuation.
These books talk more about discovering red flags in earnings and do not discuss how to read a financial statement. Some people before they consider becoming investors should take some classes, or go to business school, or get a CFA so they have basic knowledge.
Security Analysis of course is one of the original books. If you read these books you will learn accounting.
Value investing is just buying something for less than it is currently worth. Why is it so misunderstood? It seems simple to understand but most people don’t get it , why?
Most people can fairly quick understand the concepts. I think there are two main reasons people don’t practice it.
1. Value investing requires patience -- it is get rich slowly investment philosophy and most people want to get rich quickly. So the natural human inclination is to try to find a stock that will beat earnings by a penny next week and therefore the stock will jump 10%. People play short-term games trying to guess quarterly earnings.
2. To be value investor you have to be able to estimate intrinsic value. It is really hard to value businesses. You have to make predictions about the future and industry dynamics and that is very hard to do. I can tell you after getting a Harvard MBA and spending 11 years in the business it is still really hard to do.
I cannot value most businesses because they are out of my circle of competence. Even Buffett says he can’t value most businesses. I’d guess that 90% of investors do not have skill or training or experience to value businesses. And if you can’t value businesses you can’t be a value investor by definition.
Therefore you play the momentum game or short term game or some other game.
You just mentioned that the average person cannot be a value investor. Studies have shown that if you buy a basket of value stocks low P/E, low P/B etc they will outperform over time. Why can’t the average investor just buy a basket of value stocks?
It is clearly better to be fishing in the pond of smaller stocks especially if you are a small investor, as well as statistically cheap stocks (low P/B, low P/E, low enterprise value etc.). Those are the ponds you want to be fishing in. That said, there are the world’s greatest PhD mathematicians, top quants like Jim Simons, who take statistically cheap approaches. I would emphatically advise individual investors against trying to implement on their own a Dogs of Dow-like strategy or any kind of mechanical or formulated strategy. I promise you that super-computers will beat you with that.
First and foremost look at industries you know. But considering there 8,000 or so publically traded companies you want to narrow that universe; look in those industries for you know something about. Then in those industries look for out of favor, statistically cheap, beaten down stocks. Then look for those that might be able to fix themselves.
I know a lot about the restaurant industry and have made a fortune over the years investing in McDonalds, Denny’s, Yum Brands, Jack in the Box, CKE Restaurants and others. Today we are finding that the biggest blue chips like McDonalds are undervalued. Though we don’t own it, I would rather own McDonalds than the S&P 500 index fund for example. So sometimes the best risk-reward is sitting right in front of your nose.
Today an investor could do nicely – though you will not double your money quickly, but you can double it over a period of five or six years -- owning a basket of blue chip stocks like Berkshire Hathaway (one of our largest holdings), Microsoft and Pfizer. So there are a number of blue chips out there that you can own and do very nicely with.
I know your fund has been short Interoil and there are those that claim the company is all hype. But George Soros and Goldman Sachs are also big recent investors. What is your current take on IOC?
I don’t want to comment on the company specifically. The only thing I will say is I have never been in a significant short position where there was not a credible long investor with a good track record on the other side.
For example during the financial meltdown look at the value investors who were long MBIA, AIG, Fannie, Freddie, etc. So the fact that any investor is long any stock that we are short or considering shorting is not relevant. We do our own work and differing opinions are what makes markets. If you are ever going to short stocks you have to be comfortable with the fact that there will be some smart investor with the other point of view.
In your book released in mid 2009 you wrote a detailed analysis of WFC and MBIA, what is your opinion of those companies now?
I wrote the book in a span of five weeks from February to mid March.
You wrote the book in five weeks?!!
Yes, we finished the book in mid-March as the market was bottoming. The publisher turned it around and it was released in the first week of May.
In the case of MBIA, our views haven’t changed at all -- the exposure to toxic structured finance products is the same and we still think all their reserves will be wiped out.
There was an article in Bloomberg News this past week about how the major bond issuers have over $1 trillion in exposure to municipal finance bonds. We didn’t even look at that book when we analyzed our short of MBIA, but obviously states and cities across the country are facing major budget crises.
The major muni insurers, MBIA, Assured Guaranty and Ambac, cumulatively have reserved only 4 basis points of reserves against their muni finance books! This is a whole area we didn’t cover in the chapter on MBIA in our book.
MBIA is trying to get rid of their toxic liabilities by trying to create a good bank/ bad bank structure. Many debt holders are suing MBIA to have a judge rule that this is a fraudulent conveyance. So far the lawsuits are proceeding in the debt holders favor.
This is the only stock we were short that we wrote about in our book. Since it was published, many financial stocks doubled but MBIA has not moved at all because of its continuing terrible fundamentals.
With Wells Fargo, the stock has more than doubled and that has dramatically changed the risk reward ratio. We own a very small residual position but we basically exited the position because we fear the losses to come.
That said, Wells Fargo is clearly going to be able to earn its way out of trouble. Their earnings have been even greater than we modeled in our book. There is no question that this will be a $60 stock one day once the economy returns to normal. However the economy might not return to normal levels for many years -- it could be as long as five years. We think investors are rushing into financials thinking the worse is behind us and in two years we will be back to normal. However, we think it could be more than five years until we get through the whole housing and commercial real estate mess.
I would give us an A for the second half of our book where we discussed six investment opportunities – those ideas have worked out well.
Regarding the first half of the book, where we discussed the housing market, I would give us a B. Because of massive government subsidies, both constricting supply and stimulating demand, the housing market stabilized somewhat sooner and at a somewhat higher level than we anticipated. That said, the reason I would give us a B and not a C or D is because we said the aftermath of the housing bubble would be with us for years and there would be millions of foreclosures that would have to come through the pipeline to get to normal inventory levels. And all of those things are proving to be correct.
Today things are terrible out there but we are no longer in freefall. The patient is stable but critical as opposed to crashing but critical. We think the signs of a turnaround that have gotten investors excited will prove to be temporary. Even in the past week things like existing home sales, new home sales, and inventory data have been weak.
Interest rates have nowhere to go but up -- not that I am predicting that any time soon -- so things are going to remain ugly for the next few years. However, we are not so bearish that we think there is going to be a major collapse. I think the government will do what is necessary to prevent that.
And I am guessing you think there are more bank losses coming?
Absolutely. The banking system is probably between 60-65% through in terms of total write-downs that will need to be taken. This still means a number of years more of write-downs.
Sheila Bair (head of the FDIC) said this week that there will probably be more bank failures this year than the 140 last year. Smaller banks, which tend to have larger exposure to commercial real estate, will be under the greatest stress.
[What is your outlook for the economy and does that effect your investment decisions or you completely a bottom up investor?
The single biggest lesson for us of the collapse of the stock market is that it is not enough to be a completely bottoms-up investor. That is a mistake some value investors made and they paid a horrible price. We were in the Warren Buffett, Peter Lynch camp where if you spend more than 10 minutes a year focusing on macro concerns, that is ten wasted minutes.
We discovered that the way you calculate intrinsic is usually a function of discounted cash flows -- and if the economy collapses, the cash flows forecasts can be thrown out the window and are worthless.
Therefore having an opinion of some major economic shock and taking steps to protect yourself is a prudent thing. In fact it was our obsession with housing markets that saved us. If we had not figured out that the housing market was going to collapse and taken steps to short a lot of financial stocks and protect ourselves, I don’t know if we would be around today.
We have not become top-down investors, but I would say instead of being 98% bottoms-up and 2% top-down investors, today we are 75% bottoms-up and 25% top-down. Our net exposure is very much driven by whether we think we will have a V-shaped recovery or a slower recovery.
And I assume you do not predict a V-shaped recovery?
My best guess is that there is a 20% chance of that. I think there is a 50% chance of a long, slow recovery (though not necessarily a recession) characterized by the unemployment rate remaining stubbornly high for the next 3-5 years. Finally, I think there is a 30% chance that things are worse than that. With such a wide range of outcomes and valuations reflecting only be best-case scenario, we are investing cautiously.
We aren’t perma-bears however. If you think the world is going to go to hell, then you would own gold, cash and have a big short book, but we are not doing that. We have a big short book but our long book is larger.
If you think the middle-case scenario I outlined above is going to happen (which I think is most likely), then you will invest cautiously on the long side and buy stocks with very strong balance sheets like Berkshire Hathaway and Microsoft, and then you will have a big short book to cover the downside.
If you believe there will be a V-shaped recovery you will buy speculative stocks, cyclical stocks and companies with lots of debt. We were buying those stocks 10 or 11 months ago because they were the most out-of-favor stocks, but now are the most in-favor stocks. We are selling those stocks and in fact shorting them to hedge our bets.
What are your thoughts about the Simon offer for GGP? Do you think they should accept it?
General Growth as we speak is our largest position in part because we have been letting it run. We shorted it from $40 to $1, but then, after it filed for bankruptcy and after we saw Bill Ackman take a large position and knowing his record in the real estate business (and of course after doing our own analysis), we purchased the stock. We thought the equity could get wiped out but we also thought there was a possibility of a $20 upside, so the expected value was much higher than the stock price.
Virtually everything we could have possibly hoped for has happened, and we still think there is upside even from today’s level of about $13.70.
Now that a bidding world is underway between Simon and Brookfield we think the downside is fairly limited at the current price and that higher offers are coming, so there is a good chance of getting at least $20 out of this.
The main risk we worry about is the macro risk that the world falls apart again, that the economy goes into a double dip, and credit markets freeze up. Assuming the macro environment doesn’t deteriorate materially, we think the upside versus downside equation is very favorable. I would vote for an offer above $20 and that’s where I think the bidding will eventually end up.
We believe General Growth is a unique asset that a number of buyers would love to own outright or a significant fraction of it. Brookfield is not offering an outright buyout; they are looking to purchase 30% of the company. We think the bidding goes higher so we are staying with our position.
As a Berkshire holder I am curious what you think of the BNI deal? There has been a lot of controversy over whether this deal was smart in the value investment community.
We own Berkshire and we have not modified our estimate of intrinsic value as a result of the BNI acquisition. Buffett didn’t steal BNI, but we don’t think he overpaid either.
Berkshire has $62 billion of float, so this deal makes sense for Berkshire -- and only Berkshire. We think Buffett has bought the equivalent of a utility here. The Chinese are not going to come in and build a competing railroad, so there is no foreign competition. In fact, we think globalization will benefit BNI.
The deal is not complex. Berkshire is drowning in capital and he was able to buy a good business at an okay price. When you have as much capital as Buffett, it is hard to steal something.
Do you anticipate more aggressive expansion and higher cap-ex at Burlington under BRK ownership compared to when it was independent?
No. I think Burlington will continue to operate largely the same way. I do not expect many major changes. I do not think Buffett bought BNI because he thought that under Berkshire’s umbrella he could make major changes to benefit the company.
I have heard a couple of articles speculating that BNI owns so much real estate along its tracks that it could put in fiber optic cables or wind farms, so maybe this could be a play on the continuing rise of the internet or alternative energy.
Personally, I do not put much credence in these theories and would be shocked if that was a major factor in Buffett’s purchase. But it is nice to think of a little bonus like that.
In your dividend fund you hold XOM I am curious what you think of the XTO deal and if you have an opinion why Buffett sold his stake so quickly?
Zeke Ashton runs the Tilson Dividend Fund entirely independently of Glenn Tongue and me. You can ask the question directly to Zeke. Zeke is a great manager and has actually been putting us to shame with his performance.
Glenn and I manage the Tilson Focus Fund.
You run a lot of things: a mutual fund, three hedge funds, a conference, a newsletter, and are an author. You still have quite a future ahead of you. Do you see yourself more becoming a value thinker like Bruce Greenwald or more of a value investor like Warren Buffett and others? Or a combination of both?
I think I am already doing a great deal of both. I view myself as an investor and that is my passion and my career. But I like to teach and I think there is a good ethos in the value investing community of giving back and sharing and teaching.
That is how Warren Buffett learned -- because Ben Graham was willing to teach him. That is how I learned -- because Warren Buffett was willing to teach me and others through his writings and his annual meetings.
Similarly, I feel an obligation to give back and share my experience so other people don’t have to learn things the hard way. Value investing is very, very much an experience-based business and I view being good at value investing as being akin to becoming a good brain surgeon or fighter pilot. They are both professions in which you can go to school and learn basic skills, but then you need to go out and get experience. The more experience you get, the more skilled you become, but if you get experience the wrong way, you can die so it’s important to gain experience from others who are more experienced.
For most people I suggest going work for someone who will teach you. But if you don’t have that opportunity, you can do what I did by becoming a learning machine and reading all about Warren Buffett and his annual letters and going to the Berkshire annual meetings, and then learning from Charlie Munger by going to the Wesco meeting and reading Poor Charlie's Almanack. What we try do with the Value Investor Insight newsletter and the Value Investing Congress is give people a way to learn from other smart investors.
Below are some links to some of Whitney Tilson’s websites:
www.tilsonfunds.com: Whitney Tilson’s value investing resource page
www.tilsonmutualfunds.com: mutual funds
Whitney Tilson's three books
Poor Charlie's Almanack: The Wit and Wisdom of Charles T. Munger
More Mortgage Meltdown: 6 Ways to Profit in These Bad Times
Value Investing Course: Essential Strategies for Market-beating Returns