Value Hive took it’s bye week last week. Now we’re back, healthy and ready for the second half of the season.
We’ve got a ton of content for y’all this week. More investor letters. SoftBank’s hilarious corporate presentation. Interviews with value managers, and more!
Before we jump in, make sure to subscribe to this newsletter. You’ll receive Value hive every week, completely free. Straight to your inbox.
Omaha-set-hut!
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November 13, 2019
Incredibly Pessimistic Opportunities (IPOs): Well it’s official. The Uber lock-up period is over. Insiders are free to dump their shares of the money-losing enterprise. This got me thinking, “How would investors fare if they bought every IPO and held it for five years?”
Luckily, Dan Rasmussen of Verdad Capital figured that out. And the results aren’t good. In fact, you’re better off investing in 5x leveraged companies on the verge of bankruptcy. Think about that. It’s no wonder more companies decide to stay private.
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Investor Spotlight: Two Big-Name Activists
GIFs by tenor
Two big-hitting activist investors shared their quarterly letters last week. Third Point Capital and Greenlight Capital. David Einhorn runs Greenlight. Dan Loeb, Third Point. . Their activist strategy is unique in today’s passive, quant-driven world.
Let’s dive in!
Third Point Capital: Generating Alpha in a Passive World
Loeb’s fund lost 0.2% in Q3. For the year the fund remains positive, up 12.7%. Loeb attributes much of his yearly returns to his positions in Baxter, Nestle, Sony, Campbell’s, Southeby’s and United Technologies Corp.
Activism in Loeb’s Words
Most of the letter revolves around Loeb defining his activist strategy. He initially outlines the purpose of activism in markets (emphasis mine):
“Activism allows us to create our own catalyst in concentrated positions where, by definition, we have a differentiated view of a company’s potential value based on our intervention.”
Activism in a Passive World
Loeb believes this shift towards passive investing presents more opportunity for activist investors. Loeb remarks that quants are, “making it more difficult to generate equity alpha as their algorithms evolve.” This viewpoint isn’t discouraging Loeb — it’s invigorating him.
Third Point has the highest percentage of assets in activist holdings since inception. Greater than 40%. Behind this increased exposure is Loeb’s reliance on Third Point’s six strengths:
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- Successful track record and reputation for change
- Wide range of engagement techniques with companies
- Ability to invest globally
- Deep sector expertise
- Sophisticated hedging strategies
- Large capital base with a substantial portion of long duration capital
The strategy’s worked so far. Third Point’s top five profit generators are all activist positions.
Specific Stock Ideas
Loeb discussed three of his stocks in the letter: Sotheby’s (BID), EssilorLuxottica (EL) and Sony (SNE).
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- Sotheby’s (BID): Sale
Loeb sold the final stake of BID during the quarter. The sale marked a six-year investment in the company. Loeb helped transform the company from “an old master painting desperately in need of a restoration” to a 61% return for his fund.
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- EssilorLuxottica (EL): Long
Loeb’s Thesis (from the letter): Compelling end-market growth in a defensive category. Strong market share. High returns on invested capital. Potential for incremental capital deployment and competitive moats created by brands and technology.
Loeb thinks EL can earn over 8 euros-per-share in 2023, which would double its 2019 figure.
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- Sony, Inc. (SNE): Long
We’ve highlighted Loeb’s position in SNE in past Value Hives. Unfortunately for Third Point, Loeb’s recommendations fell on deaf ears. After undergoing a strategic review with Goldman Sachs, SNE came back with nothing to change.
Greenlight Capital: Early, Not Wrong on NFLX
David Einhorn is one of my favorite investors. Not because he plays poker. Not because he’s written great books. And not because he shorts TSLA. Einhorn is one of the smartest investors in the game.
Safe to say I’m rooting for his continued success.
Greenlight returned 5.6% in Q3 bringing YTD returns to 24%. Most of Einhorn’s gains came from the long-side of his book. Now he’s back in the green with his NFLX short.
From Shares to Puts: A NFLX Short Story
Einhorn’s history with NFLX is extensive and well documented. For a while Greenlight had little to show for their short position. That is until recently. NFLX fell from $367.32 to $267.62 during Q3, marking healthy gains for Greenlight’s fund.
Einhorn expressed his short via selling shares outright. But, NFLX’s meteoric run in 2018 forced the fund to convert to put options. This move ensured a positive-ske asymmetric return profile for Einhorn’s position. While he didn’t say in the letter, we’re assuming these are DOTM, long-term puts.
Accounting for Terrible Shows
Einhorn went beyond the cash-burn, deeper in the rabbit-hole. The rate at which NFLX amortized their content differed from its length in relevance. Here’s Einhorn’s take (emphasis mine):
“NFLX structures its site to emphasize new releases and popular licensed content while library content requires an effort to watch. And yet, NFLX amortizes its content over up to 10 years, inflating GAAP margins by deferring expense recognition.”
In other words, NFLX amortizes their content longer than the show remains relevant (let alone popular).
Einhorn goes further, saying (emphasis mine), “While we enjoyed Aziz Ansari’s Right Now, we suspect 80% or more of its lifetime view has already happened. How and why does something like that deserve a multiple-year accounting life?”
So you can’t trust NFLX’s GAAP accounting figures. The $3B/year cash burn is a more realistic temperature of the company’s financial health.
When It Pays To Forget
My favorite part of Einhorn’s letter was the story of his 2008 subordinated debt investment. Greenlight bought subordinated debt in Guaranty Bank in 2008. Soon after, Guaranty Bank made a large investment in “AAA-rated tranches of Alt-A mortgage pools”. I know. Great timing, right?
After the s*** hit the fan, the FDIC went around seizing banks that held such tranches. Guaranty Bank was no exception.
Fast forward a decade. Einhorn gets a call that the FDIC wants to send him a check for the liquidated subordinated debt.
I’ll let Einhorn take us home … “In September, the FDIC contacted us and more or less asked where to send the money. It was so odd that the running joke in the office was that it was a scam. But ultimately we received the funds … and so far there have been no follow-up requests fro a ‘foreign dignitary’ with further instructions.”
The ol’ set-it-and-forget-it approach strikes again!
Musk-Watch Twitter Drama
Elon Musk and Einhorn exchanged virtual twitter-jabs late last week. You can find the exchange here. In short, Musk read Einhorn’s Q3 letter (which discussed their short on TSLA) and responded to Einhorn via open letter.
Einhorn read and responded with hilarious questions and comments. Here’s a couple of my favorite:
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- “I think facility visits would be fun (can we start in Buffalo?). I might learn the difference between your alien dreadnought factory and cars made by hand in a tent.”
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- “In September 2018, you said the receivables doubled up because the quarter ended on a Sunday. That answer wasn’t very satisfying at the time. This year, the quarter ended on a weekday. Sales are lower than they were a year ago and yet, the receivables stayed high. We are curious.”
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Movers and Shakers: A Surprising Alternative Asset Class & SoftBank’s Defiance
GIFs by tenor
We’re familiar with alternative asset classes. The fancy cars, antique paintings, gold watches. We know those. But there’s another, more attractive alternative asset class out there. And it’s hiding in your attic (or children’s closet).
LEGOs. Yep, the instruments of death that spike you at midnight actually serve a purpose.
LEGO – The Toy of Smart Investors reveals that LEGO collectibles outperforms:
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- Large-cap stocks
- Bonds
- Gold
- And other alternative asset classes
Better still, LEGOs aren’t exposed to market, value, momentum, or volatility risk. It’s a true uncorrelated asset class.
According to the report, LEGOs return an average 11% per-year with positive skew of 0.7.
Yet the report concludes that outperformance isn’t statistically significant against equity markets. But LEGOs are in fact a better asset class than automobiles, wine, and art.
LEGOs also perform more like small, illiquid stocks than anything else. This suggests that a liquidity / size return premium remains true across asset classes.
SoftBank’s Rough Quarter: Getting to Breakeven
SoftBank had a rough third quarter. It’s no surprise for those that have followed the WeWork drama. Yet despite SoftBanks shoddy WeWork underwriting, the firm doubled down on its stance.
Masayoshi Son misjudged Adam Neumann, saying, “I overestimated Adam’s good side. His negative side, in many cases, I turned a blind eye, especially when it comes to governance.”
Willful blindness if I’ve ever seen it. Son looked past Neumann’s red flags, and instead, focused only on the positives. That’s a recipe for disaster.
This isn’t stopping Son from fundraising for another fund. Yep, as if the WeWork debacle wasn’t enough of a tailwind for capital raising. The NY Times article notes that SoftBank wants to raise $100B for its next fund. This new fund will focus on artificial intelligence. Son says he’ll also invest heavily in AAPL, MSFT and similar Japanese companies.
The ‘Getting Back To Breakeven’ Fallacy
What scared me most from this interview was Son’s philosophy on ‘getting back to breakeven’. He mentioned this idea in regards to his WeWork investment, saying (emphasis mine):
“We may not be able to make a big gain, but at least we may be able to get back our investment.”
This is good old-fashioned revenge investing. Instead of admitting a valuation mistake, taking the loss and moving on, Son wants to get even. He plowed another $9B into WeWork. The farther the company’s value drops, the more hell-bent Son will be on getting back to even.
Par for the Venture Capital Course
Son’s made one great investment, Alibaba. That one investment generated $100B for SoftBank. Since then, not much progress. While Son faces scrutiny over his recent hitless streak, it’s important to realize the dynamics of venture capital. This is par for the course. You make one great investment. That investment makes up for all the losers and then some.
It’s unfair to judge Son based on every single investment he makes. He’s investing in dreams at the edge of innovation. Most will fail.
Fun With Slides
SoftBank is a $100B investment fund. You’d think at that asset level, their slide deck would look somewhat professional / put together. Well, I hate to disappoint. Check out this beauty …
Amount and time. That’s all the investor needs. We don’t need numbers or specific dates. All we need to know is that over time WeWork’s profit amount will grow. Simple as that.
And my other favorite …
Thank goodness the “future” period starts at the exact bottom of WeWork’s EBITDA. Unlike the first graph, we don’t get a time frame, nor do we get dollar amounts. Just an x-axis with zero in the middle. Turnaround time? Pssshhh, why get specific when you can be opaque?
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Resource of The Week: Dave Waters Alluvial Fund Presentation
Dave Waters of Alluvial Capital, LP released his Q3 letter. In it, he included a video presentation during his time at Willow Oak.
You can read the letter here.
The video explains Waters’ fund, his unique approach to investing and where he likes to find value. Waters starts speaking around the 3-minute mark.
In his spare time, Dave runs the website OTCAdventures.com. He posts unique, off-the-beaten-path ideas. Most are micro-to-nano cap stocks with low liquidity. My favorite!
Also, give Dave a follow on Twitter. He posts great content. You won’t regret it.
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Bonus Round: More Letters!
Thought we’d take a week off and only give you two investors letters? Get outta here! Here’s a list of some of our favorite letters over the last couple weeks.
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- Askeladden Capital: +41% YTD
Quote I Liked: “I’m not looking for hundred-baggers; that’s a bad base rate. I’m looking for two-baggers over three year horizons. The watchlist is designed to consistently surface those opportunities.”
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- Long Cast Advisors, LLC.: +22% YTD
Stocks Mentioned: INS, CTEK, QRHC, TBTC, SIFY, PSSR and SCND
Quote I Liked: “Evidence and reason both suggest that investing in small individual companies with discrete opportunity pathways that can be researched, analyzed, tested and observed, and whose shares can be acquired at discounts to their future cash flows, offers a better and safer alternative to compound capital faster than the rate of inflation, after tax, than the mass index fund approach.”
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- Bonhoeffer Capital Management: -4.8% Q3
Stocks Mentioned: TOO, GTN, CAMB
Quote I Liked: “Given its importance in valuation, growth should be a key metric that value investors use to estimate the value of securities. The first question that should come to mind when analyzing a cheap stock is, ‘What is the potential growth rate of cash flows?’”
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- Rangeley Capital: +21.70% YTD
Stocks Mentioned: IAC, YELP, AER
Quote I Liked: “Amidst this negative backdrop, what do I want to own? Since we started the fund, our portfolio companies have ranged somewhere between undervalued to extremely undervalued. They are generally recession resistant businesses with consistent cash flows and solid balance sheets.”
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That’s all I got for this week. Shoot me an email if you come across something interesting this week at brandon@macro-ops.com.
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