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Jacob Wolinsky
Jacob Wolinsky
Articles  | Author's Website |

Whitney Tilson Comments on His Latest Short Fiasco

May 23, 2011 | About:

Friday was a bad day to be short Barnes & Noble (NYSE:BKS), but we haven’t covered as we think the likelihood that the deal doesn’t go through is much higher than the likelihood of a bidding war (but given our record on the short side recently, you should go all in on BKS long). What a sign of the market we’re in. This Heard on the Street article captures what Liberty must be thinking:

And with its Nook electronic-reader, B&N estimates it has 25% of the ebook market. That doesn't negate the risks: such as how it will fare longer term againstAmazon.com's Kindle and Apple's iPad. But for Liberty, it is a reasonable gamble.

Its offer price of $17 a share implies an enterprise value of about $1.25 billion. On the face of it, that looks a little steep given B&N is expected to earn around $200 million before interest, taxes, depreciation and amortization in the fiscal year ended in April 2011. But investments in building the Nook market depressed that number.

Gabelli & Co. analyst Brett Harriss estimates B&N's book stores generated $220 million in Ebitda in fiscal 2011, while the college chain made $120 million. He applies a four-times multiple to the book chain and a five-times multiple to the healthier college chain, translating to an enterprise value of $1.48 billion. That suggests Liberty, at the $17 price, would get the loss-making digital business for free.

And the Nook could turn into a nice earner eventually. Once people buy an e-reader, they can be expected to buy lots of ebooks. While the gross profit margin on ebooks is lower than for print books, ebooks don't have shipping and warehousing costs. With this in mind, B&N projected last June ebitda would rise to $500 million by 2014.

We couldn’t disagree more – in fact, if BKS does $500M of EBITDA in 2014, I’ll shave my head, as this is a business is shockingly rapid secular decline. Amazon just announced that it Kindle book sales are up THREE TIMES so far this year vs. last year, and it now sells more books on the Kindle than TOTAL paper books (both hardcover and paperback, including books that aren’t even available on the Kindle) – see: http://phx.corporate-ir.net/phoenix.zhtml?c=176060&p=irol-newsArticle&ID=1565581&highlight=. Speaking of the Kindle, my gut, observation and informal surveys of audiences tells me that it’s total nonsense that the Nook has 25% market share today. I don’t know a single person who owns a Nook and until last week I’d never even SEEN one! In my handful of surveys of large audiences (maybe 100 people), half the hands go up when I ask who has a Kindle device or app vs. maybe 1 for the Nook. If the Nook has more than 5% market share, I’d be shocked.

Speaking of painful shorts, one of the most promotional companies I’ve ever encountered, Salesforce.com, reported a dreadful quarter, but of course the stock ripped upward. EPS fell 97% year over year to basically zero (even using the company’s bogus non-GAAP “earnings”, EPS fell 6.4%), gross margin fell from 81% to 80%, operating cash flow fell 2.6%, shares outstanding jumped 6.7% (that’s what massive stock option abuse will do), and guidance was for more losses the rest of the year. THIS justifies a $20.7 BILLION market cap?!?!?

Yes, revenues rose 34%, but nearly all of the revenue “beat” was due to currency fluctuations – and this quarter, that is likely reversing. And who cares how rapidly revenues grow if expenses grow even faster, such that profits DECLINE?! I don’t know if I’ve ever seen anything like this in the software space, where one typically sees extremely high marginal profits on incremental sales.

Yes, I know the bull case that they’re investing in growth and that they’ll soon be able to cut expenses and massive profits will follow, but I think that’s BS – marketing and sales accounted for 50.5% of revenues last quarter and that’s an absolutely necessary expense I think. To sell its products, CRM has a very aggressive, highly compensated sales force.

Here is Marc Benioff’s opening paragraph from the earnings call – “fantastic”, “thrilled” and “absolutely delighted now to be at a new level of performance” in the first three sentences! (http://seekingalpha.com/article/270964-salesforce-com-s-ceo-discusses-q1-2012-results-earnings-call-transcript):

Our first quarter was indeed a fantastic kickoff to fiscal year 2012, continuing the momentum we experienced in fiscal year 2011. And I'm thrilled to report that just one quarter into our fiscal year, we have crossed the threshold of the $2 billion annual revenue run rate. As you can see from the revenue, we are absolutely delighted now to be at a new level of performance of our company, and our revenue growth rate is accelerating.

Mark my words, this will go down in history as one of the greatest promotions of all time. It’s a market-leading, useful application to be sure, but the appropriate valuation is 10-20% of the current level.

Disclosure: None

About the author:

Jacob Wolinsky
My investment ideas have been inspired by many of value investors including Benjamin Graham, Charles Royce, John Neff, Joel Greenblatt, Peter Lynch, Seth Klarman,Martin Whitman and Bruce Greenwald. .I live with my wife and daughter in Monsey, NY. I can be contacted jacobwolinsky(AT)gmail.com and my blog is www.valuewalk.com

Visit Jacob Wolinsky's Website


Rating: 3.1/5 (11 votes)

Comments

Adib Motiwala
Adib Motiwala - 8 years ago    Report SPAM
I may agree with Tilson on CRM. However, I am not sure about shorting it. No one cares for its valuation...analysts....traders and its 'investors'......Just not worth risking capital on it...maybe LEAP puts....

What I am more interested in is this Jacob.... Is he SHORT GameStop (GME) ? Thats a stock I own and would be curious to know why he is short ( if he indeed is )....
Topwine
Topwine - 8 years ago    Report SPAM
Where is the source article for this Whitney Tilson comments ?
noblepaladin
Noblepaladin - 8 years ago    Report SPAM
@ Adib, I think Tilson is short Gamestop. I remember one of the central ideas to the short Gamestop thesis is that the game reselling business may be in a secular decline as more and more games are moving to a download model as consoles are very online oriented right now and a lot of the gaming growth is in mobile (iPad, etc) apps. Game makers like the online model and the app store model because it is harder to pirate, and the margins are much higher because they cut out the middle man retail store - I remember Activision Blizzard saying that $10 of their $50 Starcraft 2 game goes to the distributor/store, but they keep the $10 if it is brought online. I don't know how much it cost them to make the game, but that is a pretty big percentage in terms of the profit margin. I don't know enough about Gamestop's fundamentals to comment on it specifically, it may be cheap enough that this is all priced in.
Adib Motiwala
Adib Motiwala - 8 years ago    Report SPAM
Well, he may be right. But, once again it comes down to timing. From GameStop's recent quarterly result, it does not look like the used game business is going out any time soon. I have been long GME since March 2010 when it was $19-$22.

yswolinsky
Yswolinsky - 8 years ago    Report SPAM
Adib agree about CRM

Topwine his email
Adib Motiwala
Adib Motiwala - 8 years ago    Report SPAM
I feel like asking Mr Tilson to explain his short thesis on GME. I really dont want him to get crushed as GME is executing like crazy.
shaved_head_and_balls
Shaved_head_and_balls - 8 years ago    Report SPAM
"Speaking of the Kindle, my gut, observation and informal surveys of audiences tells me that it’s total nonsense that the Nook has 25% market share today. I don’t know a single person who owns a Nook and until last week I’d never even SEEN one! In my handful of surveys of large audiences (maybe 100 people), half the hands go up when I ask who has a Kindle device or app vs. maybe 1 for the Nook."

Is this type of analysis supposed to make people want to throw money at hedge fund carnival barkers? Maybe if the author of the quote spent more time around women, he might see different survey results. Nook Color is marketed towards women (partly because women read far more physical books than men, so it's a big untapped opportunity).

As I recall, Tilson's record was not good when the market fell apart in 2008-9. He's typical of the baby boomer money managers who have experienced only one era of stock market valuations (An era of inflated valuations due to increased demand for stocks from an increasing pool of dumb, greedy investors, also known as Baby Boomers).

balajisridharan
Balajisridharan - 8 years ago    Report SPAM
While I agree with Tilson that the valuations are high and unsustainable. In the absence of a catalyst, it is almost irrational to try and short just based on valuation....

The markets ability to stay irrational will probably outlast Tilson's ability to hold the investment....
Adib Motiwala
Adib Motiwala - 8 years ago    Report SPAM
Yes, I was surprised to read where he says things based on " I don't know any one who owns a Nook".....He also had done some surveys about NFLX. Not sure if that helped him or not.

rgosalia
Rgosalia - 8 years ago    Report SPAM
Adib,

About GameStop, there are two issues that the shorts are missing, in my opinion.

(1) Many gamers prefer to purchase a physical disk (instead of a download) because of the trade-in value once they are done playing. From what I remember, this is a significant % of revenue at GameStop.

(2) As games get more sophisticated, they are getting larger (5GB+). Game developers are not focusing on optimizing the disk footprint of the game. Online download speeds are going to lag the game size generally making it not the same as a movie download or streaming.

In the medium-term, these two issues are quite powerful. On the other hand, in the longer-run, there is some threat to the brick-mortar model as gaming companies are trying to limit the trading of games by keeping the customer captive to the physical disk through regular updates. As an example, Dance Central, a popular XBox game comes with 30 songs on the disc, but XBox releases a new song every week downloadable for $3.00 provided you still have the disk. This is trend that many gamers are expected to catch on with the new games.

I took a look at GameStop a few months back and took a pass.

yswolinsky
Yswolinsky - 8 years ago    Report SPAM
"As I recall, Tilson's record was not good when the market fell apart in 2008-9. He's typical of the baby boomer money managers who have experienced only one era of stock market valuations (An era of inflated valuations due to increased demand for stocks from an increasing pool of dumb, greedy investors, also known as Baby Boomers)."

I only met one person ever who had positive returns in 08, and another one who was only slightly down-Maurisz of _http://classicvalueinvestors.com/i/. Both used no shorting.

Tilson started in 99 when the tech bubble was near his peak. He lived through two awful bear markets, so have no idea what you are talking about.
Adib Motiwala
Adib Motiwala - 8 years ago    Report SPAM
You mean 08 Jacob? 09 everyone killed the market since march lows....
Adib Motiwala
Adib Motiwala - 8 years ago    Report SPAM
I will submit my Long thesis on GME from March 2010. I think a lot of those things are still valid.
Ben Strubel
Ben Strubel - 8 years ago    Report SPAM
It's my understanding that Tilson was short GameStop back in 2007-2008 or so before the crash when it was close to $60. I believe his thesis was that video game sales were not as recession proof as people thought (he was partially right I guess depending on how you want to look at it) and has long since covered.
Adib Motiwala
Adib Motiwala - 8 years ago    Report SPAM
Ok. Then he was right. I thought i saw a short position for him on GME.
adamcz
Adamcz - 8 years ago    Report SPAM
He's right to short GME. The ability to download complete multi-gig games already exists, and works very well. The efficient economics of digital distribution are unavoidable. The content owners will demand it eventually.

CDs got killed, books are in the process, and physical games are next.

If you think you can time the market and sell your GME shares before the public wakes up to the inevitable future of digital downloads, good luck.
Adib Motiwala
Adib Motiwala - 8 years ago    Report SPAM
Adam,

How many of the latest multi-gig games are currently available for downloads? How long does it take? What is the size of the typical multi-gig game v/s the size of the hard drive? How many of such games can you store on the consoles?

GME acquired a company for digital distribution, online gaming and streaming. So they are trying to look ahead and participate in that.

I am not trying to time the market. My time horizon is longer than people who think companies die instantly. Its called Time arbitrage :)
yswolinsky
Yswolinsky - 8 years ago    Report SPAM
Sorry Adib I meant 08, I just corrected it.

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