Whitney Tilson is attempting to clarify questions related to his big short of K12 Inc. (NYSE:LRN). Specifically, some have claimed that Tilson has a conflict of interest related to his short. Below is his latest from Tilson sent to ValueWalk via email. See more from Tilson on the company here and here.
Via Whitney Tilson
I’ve had many conversations with various folks about K12 since I went public last week with my presentation about it (which I continue to update regularly – the latest version is always posted at:www.tilsonfunds.com/K12-
Two of my friends wrote the following: “You have an ineradicable conflict of interest on this one.”And “I think you lost the moral high ground when you shorted the stock. I wish you had stuck to your role as a reformer on this one.”
I’m glad they told me this because I’m sure many others have similar feelings and I’d like to address them.
While I do much more investing on the long side, I’ve also been shorting stocks in the funds I manage for more than a decade.
I’m well aware of the widespread perception that it’s vaguely nefarious and un-American to bet against a company – and even worse to publicly speak out against a company. If you stop and think about it for a moment, however, you’ll quickly realize how foolish this viewpoint is. Healthy markets need a vigorous debate about the level of the market overall as well as the valuation and prospects of specific sectors and companies. Imagine the bubbles that would form if everyone only said and thought positive, bullish things. In fact, you don’t have to imagine this at all: just look at two of the biggest bubbles and busts in history just in the past 15 years – among internet stocks and the housing/debt bubble – and the horrific consequences. I would argue that had there been more skeptics (like me) who were warning – it turns out, 100% accurately – about these bubbles, they wouldn’t have grown as large and the aftermath wouldn’t have been so painful.
So now let’s turn to: a) my short position in K12’s stock in the funds I manage in my day job as a hedge fund manager and; b) my public criticism of the company, in part using my platform as an ed reformer (my night job). Is my friend right that I have “an ineradicable conflict of interest”? Absolutely! But isn’t it funny how nobody ever points out that the management and board members of K12, who own tens of millions of dollars of K12 stock and are regularly granted copious amount of stock options, have a conflict of interest as well?
In fact, their conflict of interest is exponentially larger than mine. They stand to reap millions of dollars if the stock goes up – far more than I would gain if the stock goes down. And this is only one of dozens of investments in my funds (while it’s my biggest short, it’s only a bit over a 3% position), so whether K12’s stock continues to rise or collapses (as I expect), it is not going to have a meaningful impact on my business or life. In contrast, if K12 is, to quote Jeff Shaw, the former head of K12’s Ohio Virtual Academy, “a house of cards that is going to collapse,” this would have an enormous financial impact on the senior executives at the company, could cost them their jobs, lead to them being investigated, etc. So let’s be clear: they have far more incentive to try to put lipstick on this pig than I do to point out that it is, in fact, a pig.
But what about my other friend’s comment that I “lost the moral high ground” when I shorted the stock and that I should have “stuck to [my] role as a reformer”? To answer this question, allow me to give you the timeline. I first shorted K12’s stock more than 16 months ago in May 2012, periodically added to the position over the next year, and haven’t traded in it at all since May of this year. As with most of my short positions, I didn’t disclose or discuss my K12 short position until two weeks ago.
So what changed and led me to go public? The answer is simple: I spoke for the first time with a former K12 employee (Jeff Shaw) two weeks ago and since then have spoken with a number of other former employees and others who know the company well. These conversations, in turn, led me to do even deeper research into the company’s business practices, academic results, etc.
I struggle for words to describe my feelings about what I’ve found. Horrified doesn’t begin to express it. I already believed that K12 was doing some bad things – that’s why I was short the stock – but when I really started digging, I discovered that things were far worse than I’d realized: the student churn, the way the company increasingly targets the most at-risk kids even though it knows that nearly every one of them is sure to fail, the likely bilking of states via enrollment fraud, the way it effectively controls many of the nonprofits that have been granted charters and siphons all of the profits out of them, the buying of politicians, etc.
But worst of all are the academic results. I’ve never seen anything like it. The numbers at every K12 school I’ve seen make the old Locke HS in LA – once the most notorious high school in America before Green Dot took it over – look like Stuyvesant! Look at the data from Tennessee in my presentation (pages 49-50), which shows that the students at the K12 school had less academic growth by far than all 1,300 other elementary and middle schools in the state):
Or consider Ohio, where the state recently reported that the six biggest cyber schools in the state all got Fs on their state progress reports, with OHVA doing worst of all. The state counts a progress score of -2 as a complete failure for a school – and OHVA’s score was -27! Here’s a chart from the article below:
Having become convinced that K12 has run amok and is doing real educational damage to tens of thousands children every year – and giving our entire movement a huge black eye – what was I supposed to do? Remain quiet? Ha! Cover my position before going public so people wouldn’t criticize me for my conflict of interest? What would my investors think of that? I did a ton of research, made an investment based on my conclusions from that research, and then I’m supposed to get rid of that investment because someone might criticize me? Ha!
To be clear: I am not bearish on K12 because I am short the stock. Rather, I am short the stock because I am bearish on K12. Anyone who knows me knows that I’d be saying and doing exactly the same things whether