Whitney R. Tilson and Glenn H. Tongue phone: 212 386 7160 Managing Partners fax: 240 368 0299 www.T2PartnersLLC.com

November 1, 2011

Dear Partner,

Our fund rose 7.0% in October vs. 10.9% for the S&P 500, 9.7% for the Dow and 11.2% for the Nasdaq. Year to date, it’s down 24.5% vs. +1.3% for the S&P 500, 5.5% for the Dow and 1.9% for the Nasdaq. Our fund’s performance during the month was roughly in line with what we would expect given that it is nearly 70% net long.

Our long book outpaced the market in October, led by SanDisk (25.6%), Citigroup (23.3%), J.C. Penney (19.8%), Goldman Sachs (15.9%), Howard Hughes Corp. (14.0%), Dell (11.8%), and Berkshire Hathaway (9.5%). The only loser of note was Iridium warrants, which fell 11.8%.

Our short book offset nearly half of our gains on the long side due to Ethan Allen (45.5%), Boyd Gaming (32.2%), Philips-Van Heusen (27.8%), Nokia (18.9%), and Salesforce.com (16.5%). There were two winners of note on the short side, Green Mountain Coffee Roasters (-30.0%), which tumbled after the presentation by Greenlight Capital’s David Einhorn at the Value Investing Congress (see: http://valueinvestingletter.com/david-einhorns-presentation-from-the- 7th-annual-new-york-value-investing-congress.html), and First Solar (-21.3%).

Tax Estimates Please email or call Kelli at [email protected] or (212) 386-7160 if you would like to receive your tax estimates as of the end of October, which will be available in mid to late November.

Netflix We established a position in Netflix near the end of the month on the day the stock crashed 35%. Given our unsuccessful timing of being short this stock – a highly frustrating experience – it wasn’t easy to overcome the emotional baggage and think about Netflix with a fresh perspective, but we’ve concluded that it’s an excellent company and that the market has over-reacted to all of the recent negative news, thereby providing us the chance to own it at a cheap price.

Netflix today reminds us of BP 16 months ago (which was a huge winner for us): the company, its CEO and the stock are all universally hated right now, with endless headlines of furious customers and shareholders. We love situations like this – as long as we’re convinced that there’s a good company and a cheap stock once you cut through all of the noise.

And we do think Netflix is a good company – something we acknowledged when we were short it, but didn’t fully appreciate at the time. Once we did – we think it’s an excellent company – we covered. Here’s what we wrote in our article, Why We Covered Our Netflix Short, published on Feb. 9, 2011 (posted at: http://valueinvestingletter.com/why-we-covered-our-netflix-short.html):

The GM Building, 767 Fifth Avenue, 18th Floor, New York, NY 10153

…while we acknowledged in our December article that Netflix ?offers a useful, attractively- priced service to customers, is growing like wildfire, is very well managed, and has a strong balance sheet,? we now believe that it is an even better business than we gave it credit for. The company has enormous momentum and substantial optionality (for example, international growth), and management is executing superbly.

Obviously the momentum has been broken due in large part to management not executing superbly, but we still think it’s an excellent company – and credit Reed Hastings for quickly acknowledging and fixing the Qwikster mistake.

We were short it primarily because of the extreme valuation of the stock – but now that it’s down nearly 75% from its peak less than four months ago, we think it’s downright cheap. Attached in Appendix A is an article that captures many of the reasons we’re bullish, which concludes:

And one of the reasons everyone thought Reed Hastings was a genius, by the way, was Reed Hastings’ demonstrated willingness and ability to suffer short-term pain in exchange for presumed long-term gain.

How did everyone learn that about Reed Hastings?

They learned that back in early 2004, when Reed Hastings slashed Netflix’s prices and ramped up marketing spending to compete with a new DVD service from Blockbuster that many people thought was going to destroy Netflix.

Reed Hastings’ price cuts and spending increases did not go over well with Netflix’s shareholders. In fact, as you can see in the chart below, Netflix’s stock fell even more then than it has now: 75%+






But Reed Hastings was right. The company that was supposed to kill him, Blockbuster, went bust. And Netflix’s stock went on to soar 30X from the 2005 low.

Now, thanks to the stumbles of the past few months, everyone thinks Reed Hastings is a bonehead again.

And maybe, this time, Reed Hastings will turn out to be a bonehead.

But this observer, anyway, is not going to be betting against him. Especially because Reed Hastings has already demonstrated his ability to bet the company and be right. And because Netflix’s future — streaming over the Internet instead of cable networks — already looks to be a pretty good and pretty big business.

In addition to the points in the article, we’d add the following:

• With 23.8 million subscribers (excluding 1.5 million international ones) and a market cap of $4.4 billion, Netflix is being valued at $186/subscriber, a very low figure relative to other media companies.

• Its shrunken market cap means that Netflix would be a bite-sized acquisition for any number of much larger companies like Apple ($376B market cap), Google ($192B), Amazon ($97B), Comcast ($64B), or Disney ($65B). We don’t think an acquisition is likely, but it probably puts a floor under the stock.

• By all accounts, streaming usage is growing very rapidly – 30-40% annually we’d estimate. It seems likely that Netflix will get the lion’s share of this because there are no meaningful competitors. A key pillar of our short thesis last year was the rapid emergence of numerous competitors, but it just hasn’t happened. Hulu Plus, which is owned in part by Comcast and Disney, just passed the one million paying subscriber mark, not even 5% of Netflix’s level. Amazon is offering free streaming videos to Amazon Prime members and boasted in its recent earnings release of a library of ?more than 12,000 movies and TV shows from partners such as CBS, FOX, PBS, NBCUniversal, Sony, Warner Bros., and many more,? but Netflix in its earnings release said ?we have not seen much usage of Amazon Prime in our research.? If Comcast, Disney or Amazon wanted to get serious about this nascent market, it would be much easier and less costly just to buy Netflix.

• This is a really rough number, but we think Netflix should eventually be able to earn $5-6 of contribution profit per customer per month (a bit less than half of average revenue of approximately $12.50) if – and this is a big if – it can grow its subscriber base meaningfully over time. This translates into $1.3-$1.7 billion of contribution profit (again, excluding Netflix’s nascent international operations).

• We think Netflix was smart to raise its price – our only critique is how Reed Hastings communicated it. Had he done a better job explaining it, perhaps fewer customers would be so furious. It might not be too late to send out a letter like this one:


Dear Netflix subscribers,

I understand that many of you are upset by our recent price increase. We didn’t want to do it, but it was necessary. Allow

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