From Whitney Tilson’s latest email to investors

I gave a presentation recently to MBA students on two of my favorite stocks, Google and Spirit (I deliberately picked two very different types of investments). I’ve posted my slides here (www.tilsonfunds.com/GOOG-10-17.pdf) and here (www.tilsonfunds.com/SAVE-10-17.pdf). (Interestingly, Spirit is back to almost the exact price it was when I first bought it – and pitched it at the Robin Hood Investors Conference (my slides from then are at: www.tilsonfunds.com/SAVE-10-15.pdf) – two years ago; it then nearly doubled before falling back.)

Get The Full Seth Klarman Series in PDF

Get the entire 10-part series on Seth Klarman in PDF. Save it to your desktop, read it on your tablet, or email to your colleagues.

2) Berkshire of course remains one of my favorite stocks. I haven’t updated my slides in a while (they’re always posted at: www.tilsonfunds.com/BRK.pdf), but I enjoyed this 34-page BRK slide presentation by Prof. David Kass of the Univ. of Maryland business school: http://www.valuewalk.com/wp-content/uploads/2017/10/Concordia-Presentation-v4.pdf

3) I really enjoyed my friend Zeke Ashton’s September letter (attached) to the investors in his hedge fund, the Centaur Value Fund (full disclosure: I own a small piece of Zeke’s management company). In it, he shares his thinking about the difficulty of being a value investor in the long, complacent bull market. Excerpt:

 

In the current environment we aren’t seeing ideas with obviously better value, and we are doing our best to maintain the Fund’s targeted minimum market exposure of around 40%.

 

This is probably a good time to make it clear that we find ourselves slowly and carefully moving the acceptability lines at the margins of our buy and sell discipline in our efforts to keep capital productively deployed in this very expensive market. We are doing our best to be both thoughtful and prudent about how much we do so. We know that the temptation to change one’s valuation standards in and of itself is probably a late market cycle indicator. However, I do think that some accommodation and adjustment to our discipline on the sell side was probably somewhat overdue. I think we’ve historically been too quick to pull the sell trigger and accept a good outcome on certain investments when we could have held on longer and gotten a great outcome. This requires being willing to let valuations on certain positions run a bit further into the fully valued part of the spectrum before selling. In general, we feel that we have more room to compromise on the sell side of the decision cycle than the buy side. But there, too, we expect that we might be willing to pay up a little more for stocks in two primary cases: 1) businesses of obviously superior quality and safety, and 2) those businesses in the sweet spot of our analytical capabilities where we are most confident.

 

Now that I’ve warned you that we expect to have to pay a little more and hold on a little longer to our portfolio holdings than we have in the past, I also want to reassure you that we will not forget that we are value investors and that job number one for us will always be the avoidance of permanent capital loss. In our March letter we commented on the combination of exceptionally low market volatility and historically high equity prices, and how that introduced a tremendous challenge for value and risk-conscious investors.

 

… There is an argument I’ve read in many different iterations over the past year or two that investors need not worry about market valuation levels until one sees clear signs of euphoria and speculation. The implication is that “you’ll know it when you see it” and that before a market can break, there always has to be a tell-tale “blow-off” top.

 

Those of us who were investing in the late 1990’s easily remember the crazy speculative behavior and the popular manias surrounding internet, telecom, and biotech stocks. It was also fairly commonplace at the time to read stories in the news featuring completely sane-looking people quitting respectable jobs so they could make more money day-trading tech stocks. More recently, many of us remember the media stories about the housing boom in 2005 and 2006 when speculators would show up on the opening day of a new housing development and buy five houses on credit in order to flip them later. We’re generally not seeing that kind of obviously speculative behavior being reported in the financial media with regards to stocks today. In fact, nobody seems particularly euphoric about stocks, which is a little strange given the strong returns of the past few years. Most professional managers I talk to certainly seem cautious or at least concerned about valuations (even those that remain fully invested). Stock market sentiment amongst the general public is hard for me to gauge, but from where I sit it seems that the best description of the mood would be something close to ambivalence. Certainly, the really cool kids aren’t talking about the stock market at all, because they are all too busy buying crypto-currencies and investing in early stage venture capital, or maybe selling put options on volatility ETFs.

 

One could even push the logic further and argue that this lack of perceptible euphoria is, in and of itself, a reason to be bullish about stocks. Given how far it appears we are from the level of wildly enthusiastic participation that marked prior bull market tops, this current bull market may have many years to go. With the global economy finally showing signs of real growth that will start to be reflected in public company earnings, markets could go higher as this translates into earnings growth that could more than justify current lofty valuations.

 

4) Kudos to the patient investors who bought (and, critically, HELD) bank TARP warrants (I was in a few of them 5+ years ago, but got fatigued and sold – timing is everything!). Bank Bets Tied to Government Bailouts Soar Up to 1,440% in a Year, https://www.wsj.com/articles/bank-bets-tied-to-government-bailouts-soar-up-to-1470-in-a-year-1509964202. Excerpt:

 

The U.S. banking industry is booming—a development that is bringing windfall gains to a small group of investors who had the gumption to buy esoteric bank securities when the outlook for financial firms and the economy was far less clear cut.

 

After years of banks grappling with the fallout of the crisis and low interest rates, the bets on what are known as TARP warrants are finally paying off. The investors, who include fund managers John Paulson and Bill Miller, bought these warrants for bank stocks secondhand, after they were initially issued to the government during the 2008 bank bailout.

 

The investors’ unpopular view at the time was that banks and their stock prices would recover to precrisis levels. By betting on warrants, a high-octane security similar to an option, the fund managers basically doubled down on that opinion, risking their entire investment if it didn’t happen by 2018 or 2019.

 

“If the subprime credit-default swaps were this asymmetric, beautiful investment to express what was wrong with American capitalism…, these securities are the opposite,” said Django Davidson, a founding partner at London-based Hosking Partners LLP, which bought about $200 million of the warrants for banks including Bank of America Corp.

 

5) Another blast from the past. Year ago, I was short Questcor, whose sole product was HP Acthar, a tiny, niche, half-century-old drug that QCOR acquired and jacked the price up a zillion percent (from $40 to $36,000 – I’m not exaggerating), then started marketing it for a wide range of illnesses for which there’s no evidence whatsoever of efficacy, and then plowed roughly a third of the excess profits back into basically bribing doctors to prescribe it. In short, a total scam (well, 99% anyway).

 

But it was a painful short because regulators, insurers and the government did nothing and then Mallinckrodt came along and bought QCOR. I rolled the short into MNK, but eventually covered when there continued to be no action to rein in HP Acthar and the company got caught up in the specialty pharma bubble (Valeant, Endo, etc.), resulting in it doubling to a peak of $133.60 in early 2015 (again, timing is everything!).

 

Since then, it’s been pretty much all downhill as the general bubble has burst and, in particular, various parties are finally cracking down on the HP Acthar scam (which accounts for 40% of MNK’s sales currently) and the stock has now collapsed to $22.40. If there’s any justice, it’ll go to zero and people will go to jail.

 

Wall Street's most hated drugmaker is getting annihilated after a bizarre conference call, http://www.businessinsider.com/mallickrodt-misses-revenue-q3-earnings-2017-11. Excerpt:

 

How’s this for an excuse for a lousy earnings report. Doctors are prescribing our blockbuster drug like crazy, but people just aren't filling prescriptions.

 

The drug in question is called Acthar, and Mallinckrodt (and its previous owners) have turned it into a billion dollar a year product by jacking up its price to above $36,000. This happened even though it's so old that it predates the FDA approval process we have in place today.

 

Thanks to the fact that those prescriptions are going unfilled, Mallinckrodt's third-quarter revenue came in below analysts expectations. The stock fell more than 19%.

 

Mallinckrodt didn't have a good explanation for why this was happening, only to say that it was "an issue more widely impacting some companies in the branded pharmaceutical industry."

 

In fact, over and over again, on a head-scratcher of a conference call — executives kept pointing to "the market environment for specialty pharmaceuticals."

 

Or, what they may very well mean is that insurance companies and others who have to pay for drugs — and have been stuck with the tab for these obscure medicines that once cost $40 a vial and now cost nearly $40,000 — are wising up.

 

Acthar, which makes up around 40%* of Mallinckrodt's revenue, has been the subject of intense scrutiny on Wall Street and in the medical community.

 

6) It’s high time for the SEC to not only TALK tough on cracking down on these total scams (which have raised $3 BILLION this year) and actually ban then (as the Chinese have wisely done). SEC Chief Fires Warning Shot Against Coin Offerings, https://www.wsj.com/articles/sec-chief-fires-warning-shot-against-coin-offerings-1510247148. Excerpt:

 

SEC Chairman Jay Clayton said so-called initial coin offerings in many cases looked like securities, raising the prospect the agency will take a more aggressive stance to this red-hot fundraising method.

 

“I have yet to see an ICO that doesn’t have a sufficient number of hallmarks of a security,” Mr. Clayton said in an unscripted remark delivered in the middle of a speech at the Institute on Securities Regulation in New York Wednesday .

 

Mr. Clayton’s remarks suggest firms using the coin offerings, also known as ICOs, to raise cash in the U.S. may need to register the deals with the SEC and provide investors with extensive disclosure documents, depending on how broadly they market them. Startups that once conducted virtually unregulated token sales will likely have to consult lawyers and other gatekeepers to advise them on how to navigate laws and rules overseen by the SEC.

 

An initial coin offering is a method of capital raising among cryptocurrency-related startups that has exploded in popularity this year. In an ICO, firms simply create and offer a new token to investors. The process can be as simple as adding a few lines of code to an existing project.

Related articles

 

There have been more than 160 of these ICOs this year, which have collectively raised more than $3 billion, according to data from research firm Coindesk. Before this year, ICOs had raised a total of about $300 million going back to 2014.

 

7) More signs of the times… In 2017, Investors Can Either Buy Bubbles or Be Left Far Behind, www.bloomberg.com/news/articles/2017-11-09/in-2017-investors-can-either-buy-bubbles-or-be-left-far-behind. Excerpt:

 

The best way to crush the crowd in 2017? Buy the things everyone insisted would never keep going up.

 

A portfolio stuffed with allegedly over-inflated assets would have returned more than 120 percent so far in 2017, trouncing the S&P 500 Index and underscoring the challenge for investors facing a plethora of pricey securities.

 

The hypothetical ‘Bubblicious’ portfolio includes Chinese real estate and internet names, a pair of U.S. tech behemoths, a cryptocurrency fund, the ETF industry, bonds that mature decades from now, and a dash of short volatility bets just to make things more interesting.

 

The out-performance is a testament to the momentum mania prevalent in today’s markets, a dynamic which has prompted the likes of Greenlight Capital’s David Einhorn, Goldman Sachs Group Inc., and Sanford C Bernstein & Co. LLC to mull whether value investing is in the midst of an existential crisis given ultra-low interest rates and abundant liquidity.

 

8) I’ll let you draw your own lessons from this… 'Dr. Doom' commentator Marc Faber faces backlash over race comments, www.reuters.com/article/us-people-faber/dr-doom-commentator-marc-faber-faces-backlash-over-race-comments-idUSKBN1CM31D. Excerpt:

Centaur Value Fund-Sept 17 letter