Whitney Tilson: Selected Published Columns

http://www.tilsonfunds.com/

Should Warren Buffett Call It Quits?

By Whitney Tilson
Published on the Motley Fool web site, 4/3/00

(http://www.fool.com/boringport/2000/boringport000403.htm)

Julian Robertson announced at the end of last week that he was closing down Tiger Management. Less than two years ago, Tiger was the largest hedge fund group in the world, with $22.8 billion in assets, and had compounded investors’ money at 32% annually for nearly 18 years. But dismal performance over the past year and a half, which triggered massive investor redemptions, has led to Tiger’s demise.

It’s remarkable — and somewhat disconcerting for a money manager like me — to see how quickly the tide can turn. Tiger was up 69% in 1997 and an additional 17% through the first three quarters of 1998. But an ill-fated short position in the yen led to an 18% decline in October and Tiger ended 1998 down 4% for the year. It got worse in 1999, as Tiger fell 19%, trailing the S&P 500 by 40 percentage points, and in the first two months of this year, it was down another 13.5%. That’s a 43% decline in less than six quarters, during which the S&P surged 35%. Ouch! Despite ending with a whimper, Robertson’s 20-year track record was spectacular, as he generated 25% annualized returns (versus 17.5% for the S&P) over that period.

In his parting words, Robertson claimed we are experiencing “an irrational market, where earnings and price considerations take a back seat to mouse clicks and momentum…. The current technology, Internet and telecom craze, fueled by the performance desires of investors, money managers and even financial buyers, is unwittingly creating a Ponzi pyramid scheme destined for collapse…. There is no point in subjecting our investors to risk in a market which I frankly do not understand.”

Hmmm. Famed value investor expresses skepticism about a manic stock market and predicts a severe correction. But the investor loses 19% last year and posts double-digit losses in the first two months of this year, triggering the flight of all but the most faithful investors. Media vultures circle. Sound familiar? This description fits not only Robertson, but also Warren Buffett and his investment vehicle, Berkshire Hathaway (NYSE: BRK.A). How this market has humbled even the mightiest value investors!

Robertson’s action raises the obvious question: Should Buffett follow his lead and call it quits? My answer is an emphatic no — not surprising, given that Berkshire Hathaway is my largest holding — and I’d like to explain why.

The Difference Between Buffett and Robertson

Buying the shares of even the worst company at a low-enough price can be financially rewarding. Still, as a general rule, I’m skeptical that there’s much genuine value in companies trading at low multiples but with poor financials and weak future prospects. Buffett agrees. In his latest annual letter, he wrote: “If the choice is between a questionable business at a comfortable price or a comfortable business at a questionable price, we much prefer the latter. What really gets our attention, however, is a comfortable business at a comfortable price.” If Buffett can’t find an exceptional business priced attractively, he’ll just let cash and bonds accumulate until he can find a fabulous investment opportunity.

Perhaps Robertson at one time practiced a similar style of value investing, but as valuations have soared over the past few years, he appears to have fallen into the trap of buying companies of increasingly lower quality in order to continue paying the prices to which he had become accustomed.

The contrast today between Buffett and Robertson is evidenced by the major U.S. public stock holdings of Berkshire Hathaway and Tiger Management:

 

Berkshire Hathaway

Cash/ Net 5-Year Avg. Steady Steady
Company P/E All Debt Margin ROE EPS Growth Revenue? EPS Growth?
Amer. Express 28 14% 12% 23% 18% Yes Yes
Coca-Cola 36 35% 19% 42% 16% No No
Freddie Mac 15 na na 20% 18% Yes Yes
Gillette 30 2% 13% 42% 13% No No
Washington Post 23 19% 11% 14% 15% Yes No
Wells Fargo 18 62% na 14% 14% Yes Yes
Simple Average 25 26% 13% 26%

 

Tiger Management

Cash/ Net 5-Year Avg. Steady Steady
Company P/E All Debt Margin ROE EPS Growth Revenue? EPS Growth?
Bear Stearns 8 16% 9% 15% 14% No No
Bowater 38 3% 5% 5% negative in ’94 No No
Federal-Mogul 4 2% 2% 5% 15% No No
GTECH Holdings 7 2% 10% 35% 20% No No
Navistar Int’l 7 25% 4% 28% 41% No No
Niagara Mohawk neg. 2% -1% -2% negative No No
Pittston Brink’s 10 37% 5% 17% 20% Yes Yes
Sealed Air 27 4% 7% 17% 26% Yes No
Starwood Hotel 16 3% 6% 6% negative No No
Tosco Corp. 17 5% 2% 14% 19% No Yes
UNUMProvident 6 50% na 14% 5% Yes No
US Airways 11 60% 6% 3% negative in ’94 No No
United Asset Mgmt. 16 17% 8% 29% 10% No No
XTRA 8 0% 13% 17% 7% Yes No
Simple Average 13 16% 6% 15%

 

Note: Steady revenue and EPS growth is defined as increases every year from 1994 to 1999.
Source: Value Line, 3/30/00

Pretty stark contrast, isn’t it? Every one of Buffett’s picks are characterized by steady growth (recent hiccups at longtime steady growers Coca-Cola and Gillette notwithstanding), high margins, solid balance sheets, and returns on equity that exceed the cost of capital. (These attributes would also generally be true of McDonald’s and Disney, Buffett’s largest sales in the past few years.)

While Tiger’s holdings are much cheaper in terms of average P/E (Buffett, of course, bought his stocks at low prices as well), as a group, this is a lame collection of companies. Lots of debt, low margins, poor returns on equity, erratic growth — this group of companies deserves to trade at a low average multiple!

US Airways Case Study

“When Richard Branson, the wealthy owner of Virgin Atlantic Airways, was asked how to become a millionaire, he had a quick answer: ‘There’s really nothing to it. Start as a billionaire and then buy an airline.'” — Warren Buffett’s 1996 annual letter.

Tiger owns 23% of US Airway’s shares, representing Robertson’s largest position by far. To my knowledge, this is the only stock in Robertson’s current portfolio that Buffett has ever owned (in 1989, he bought $358 million of USAir preferred stock). Here is what Buffett wrote about this investment in various annual letters:

“There is no tougher job in corporate America than running an airline: Despite the huge amounts of equity capital that have been injected into it, the industry, in aggregate, has posted a net loss since its birth after Kitty Hawk.” — 1991 annual letter.

“A competitively-beset business such as USAir requires far more managerial skill than does a business with fine economics. Unfortunately, though, the near-term reward for skill in the airline business is simply survival, not prosperity.” — 1992 annual letter.

“Mistakes occur at the time of decision. We can only make our mistake-du-jour award, however, when the foolishness of the decision become obvious. By this measure, 1994 was a vintage year with keen competition for the gold medal. Top honors go to a mistake I made five years ago that fully ripened in 1994: Our $358 million purchase of USAir preferred stock, on which the dividend was suspended in September. In the 1990 Annual Report I correctly described this deal as an ‘unforced error,’ meaning that I was neither pushed into the investment nor misled by anyone when making it. Rather, this was a case of sloppy analysis, a lapse that may have been caused by the fact that we were buying a senior security or by hubris. Whatever the reason, the mistake was large.” — 1994 annual letter.

Ironically, as Buffett was writing those words in early 1995, USAir was beginning a remarkable rise from the ashes. From its low in late 1994 to its peak in mid-1998, the stock rose more than 2,000%, which allowed Buffett to exit his investment profitably in 1997.

But not long afterward, Robertson began to buy, inexplicably ignoring the awful cyclicality and economic characteristics of this industry that Buffett had so clearly laid out in his annual letters. As the stock fell, Robertson refused to admit his mistake and, in fact, worsened it. According to an article in The Wall Street Journal:

“When US Airways began to teeter, Mr. Robertson stuck to his guns, investing even more, to the point where Tiger owned so much that one analyst at Tiger who covered the airline proclaimed, ‘We’re too long to be wrong,’ said one person familiar with the matter. Mr. Robertson still hasn’t sold a share of US Airways, faithful to the airline.”

What a contrast between Buffett’s humility in being willing to acknowledge and rectify his mistake, and Robertson’s stubbornness! While Buffett is also known for his unshakable faith in certain stocks, at least he picked fine companies in which to place his faith.

Conclusion
Robertson’s recent statement that “This approach isn’t working and I don’t understand why” shows how badly he has lost his way. Today’s market is punishing the stocks of poor-quality businesses, but that’s not irrational, it’s sensible. Regarding the low valuations of Robertson’s stocks, I think Robertson, not the market, has been making the mistakes.

Robertson once summarized his investment strategy as “buying the best stocks and shorting the worst.” Though I have no idea what stocks Robertson was shorting, in my opinion, he appeared to be doing the opposite.

— Whitney Tilson

Whitney Tilson is Managing Partner of Tilson Capital Partners, LLC, a New York City-based money management firm. Mr. Tilson appreciates your feedback at Tilson@Tilsonfunds.com. To read his previous guest columns in the Boring Port and other writings, click here.

Related Link:
Brian Graney, 3/31/00: An Investing Tiger Calls It Quits

Perils and Prospects in Tech

Technology stocks have declined significantly this year, as the market has corrected some outrageous valuations. Yet a number of “blue-chip” tech stocks still trade at very high prices and are ripe for a fall. There are, however, some good companies in the sector whose prices have become very attractive during the shakeout.

By Whitney Tilson
Published on the Motley Fool web site, 10/9/00

(http://www.fool.com/boringport/2000/boringport001009.htm)

What we are witnessing today in the technology sector is a speculative bubble bursting. I believe the process is still underway, which has important implications for investors, especially those still clinging to the few blue-chip tech stocks that are still relatively unscathed. But one need not abandon this sector entirely — in fact, there are wonderful bargains available to courageous investors with a time horizon beyond a quarter or two.

Turmoil in the tech sector

As evidenced by the Nasdaq’s 17.4% decline this year (and a 33.4% fall from its peak on March 10th — all figures as of Friday’s close), technology stocks have been hit hard recently. We’re all familiar with the demise of the dot-com sector, which I touched on in my column, Twelve Internet Myths. Leading Internet companies like America Online (NYSE: AOL), Amazon (Nasdaq: AMZN), eBay (Nasdaq: EBAY), and Yahoo! (Nasdaq: YHOO) have been whacked badly, and lesser companies are being obliterated (deservedly so by and large). Nor has the carnage been limited to dot-coms. Highly profitable stalwarts such as Microsoft (Nasdaq: MSFT), Dell (Nasdaq: DELL), Intel (Nasdaq: INTC), Qualcomm (Nasdaq: QCOM), Worldcom (Nasdaq: WCOM), and Lucent (NYSE: LU) — plus a host of solid second-tier companies like Apple (Nasdaq: AAPL), Lexmark (NYSE: LXK) and Boring Port holdings Gateway (NYSE: GTW) and American Power Conversion (Nasdaq: APCC) — have all been taken out and shot due to various hiccups (or worse) in their businesses.

Many of these companies were and still are outstanding, but they were bid up to valuations ranging from very rich to utterly preposterous by naïve or cynical investors — a frenzy cheered on by Wall Street and the media. These stocks were priced for perfection — but perfection, for most, proved impossible to achieve. This should not have come as a surprise, given the ferociously competitive and unpredictable nature of the fast-moving technology sector.

A bifurcated market

Curiously — this is why I think the bubble hasn’t finished bursting yet — some stocks have remained relatively unscathed, with their enormous valuations intact. In part, this is because these companies are in exciting sectors and have continued to deliver outstanding results. But I suspect it is also because investors have been conditioned for too long that tech stocks are the only way to make money, so instead of fleeing the sector entirely, they — like those caught in a flood where the waters are continuing to rise — have crowded onto a small handful of islands, a few blue-chip tech companies, that offer the illusion of safety.

But these stocks are not safe at all. In fact, they are extraordinarily risky. Not because there are problems with the companies — these are exceptional businesses with marvelous economic characteristics and bright future prospects — but because of the nosebleed valuations caused by all the investors piling into them.

Examples of the companies I’m talking about (I’m bracing myself for the hate emails) include Cisco (Nasdaq: CSCO), Oracle (Nasdaq: ORCL), EMC (NYSE: EMC), Sun Microsystems (Nasdaq: SUNW), Nortel Networks (NYSE: NT), and Corning (NYSE: GLW). What do these six have in common? As the chart below shows, they are very richly valued by any measure, in part because they have not been hit as hard as many stocks in the tech sector. They are also large companies — the smallest has $5.6 billion in




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