Whitney Tilson and T2 Partners provide a valuable lesson for all of us on the importance of position sizing and some diversification.
On February 23, 2011 T2 Partners filed the following document with the SEC indicating that they had taken an activist investment position of over 5% in the shares of LECG Corporation
http://www.sec.gov/Archives/edgar/data/1192305/000139834411000422/fp0002576_sc13d.htm
Based on the timing of the filing it appears that T2 was buying shares for between 75 cents and $1.
Then only a week later T2 registered this filing that revealed they had sold almost their entire position
http://www.sec.gov/Archives/edgar/data/1192305/000139834411000471/fp0002618_sc13da.htm
The bad news is that the price of LECG Corporation shares were under 25 cents down almost 80% in the one week period that T2 had to sell them !
One thing I like about Tilson is that he does not sweep this kind of thing under the rug and pretend it didn’t happen. Just as he did with his unprofitable short positions on Netflix and some other very expensively valued companies Tilson steps up and explains where he went wrong and why he made the decisions he did.
Here are his comments from his February letter to investors:
It was a historic day for us on the last day of February – but not in the way we like: one of our positions declined by 80% in a single day. You might think that such a decline is, ipso facto, proof of a mistake, but we’re not so sure (and that’s not just because we had a good day and month). Allow us to explain...
LECG is a specialized consulting firm that “conducts economic and financial analyses to provide objective opinions and advice that help resolve complex disputes and inform legislative, judicial, regulatory and business decision makers.” Our investment was based on the belief that LECG could successfully integrate recent acquisitions into a profitable business structure. Given the company's market capitalization of approximately $40 million, we felt that we had a reasonable margin of safety imbedded in the company's $109 million in Accounts Receivable, offset by $26 million of net debt.
The company's distressed stock price, under $1, was due to a default on the existing debt. Given the quantity and quality of the receivables, we believed that the default was a short-term issue and that LECG would be able to refinance debt on a secured basis, supported by the Accounts Receivable, in which case the stock could easily be a multi-bagger.
Much to our surprise and dismay, however, LECG instead announced what is effectively a plan of liquidation. We don’t know why the company pursued this path, though it is possible that this route preserved compensation agreements for employees at the expense of existing shareholders. Given the rapid execution of the liquidation, we believe the equity will end up being worthless so we sold our entire position.
In light of this permanent loss of capital, why aren’t we certain that this was a mistake, as Netflix clearly was? Because it’s possible that we made a high-expected-value bet, but just got unlucky. Investing is a probabilistic business so it does not necessarily follow that every time you lose money, you made a mistake (and, conversely, every time you make money, you made a good investment). This is very simple and, to us, obvious, but is very poorly understood.
The amount that T2 actually lost on this investment isn’t terribly significant in relation to the size of his fund. It looks like they had under $2 million invested and the amount T2 manages is now over $300 million according the their most recent quarterly filing.
Nonetheless it is embarrassing and a very clear violation of Buffett rules #1 and #2 which of course are “don’t lose money”. I admire Tilson for being forthright with his shareholders and explaining exactly what happened and why.
