Whitney Tilson: Carried Interest Loophole & Rubenstein’s Fight To Save It

Whitney Tilson, in his email, discusses how Trump made millions off his biggest business failure; he is the devil; new Berkshire Hathaway slides; Munger Management; a hedge fund manager helped save Siberian tigers; my test drive of the Tesla Model X; the carried interest loophole & David Rubenstein’s fight to save it.

Whitney Tilson – How Trump made millions off his biggest business failure

1) Now that Trump is 70% likely to be the Republican nominee (though thankfully only 19% likely to become President) (see: https://electionbettingodds.com), it’s time to start looking at his business record – and, not surprisingly (like virtually everything else he says), his claims are a far cry from the truth. Here’s an excellent piece of journalism by Fortune’s Shawn Tully looking at Trump’s record at the only public company he’s ever run:

As a businessman, Donald Trump gained fame as a gambling czar rivaling his renown as a developer. But a close examination of his record in gaming reveals that while Trump profited richly, his stock and bondholders could hardly have fared worse. It’s undeniable that Trump’s special arrangements with his casino company displayed his trademark creativity. Among the most imaginative deals was a package that gave him a bonus despite the fact that his casino empire was losing tens of millions of dollars a year, and an agreement to that had the casinos spend hundreds of thousands of dollars a year on Trump Ice bottled water for the mini-bars. That’s a lot of chips for flat aqua bottled in plastic.

From mid-1995 to early 2009, Trump served as chairman of Trump Hotels and Casino Resorts (renamed Trump Entertainment Resorts in 2004), and held the CEO title for five years (mid-2000 to mid-2005). During Trump’s 13 years as chairman, the casino empire lost a total of $1.1 billion, twice declared bankruptcy, and wrote down or restructured $1.8 billion in debt. Over the same period, the company paid Trump—essentially Trump paying himself—roughly $82 million by Fortune’s estimates, collected from a dizzying variety of sources spelled out in the company’s proxy filings, as varied as payments for use of Trump’s private plane to fees paid directly Trump for access to his name and marketing expertise.

…Trump Hotels and its successor, Trump Entertainment, filed for bankruptcy in late 2004, then again in early 2009, when Trump finally departed as chairman. The company’s travails weren’t over. It surrendered to chapter 11 a third time in 2014. It’s now a subsidiary of Icahn Enterprises, run by The Donald’s now friend, legendary financier Carl Icahn.

No amount of spin will make Trump’s dozen years at the helm of a Trump Hotels, the only public company Trump has ever run, look like anything but a flop that damaged thousands of shareholders, bondholders, and workers. The sole “winner” now packs arenas across America, mesmerizing tens of thousands of cheering fans with tales of his business triumphs.

For a hilarious look at more of his lies (just a few days ago) about his businesses, see this clip from The Daily Show: http://www.cc.com/video-clips/ml4hgx/the-daily-show-with-trevor-noah-donald-trump-s-victory-speech-infomercial. And here’s an article in today’s NYT about the complete scam he ran: At Trump University, Students Recall Pressure to Give Positive Reviews.

For the record, I think Donald Trump is the devil. He embodies – and brings out – the very worst in human nature. He appeals to base instincts and whips up hatred: racism, xenophobia, misogyny, etc. I can think of no greater threat the long-term future of this country than him becoming President, and I will do everything in my power to stop this from happening.

Whitney Tilson – New Berkshire Hathaway slides

2) Buffett released his 2015 annual letter two weeks ago and I have updated my updated Berkshire slide presentation (posted at www.tilsonfunds.com/BRK.pdf).

I now peg intrinsic value at $283,000/A share (equal to 1.82x book), based on $159,794 of investments per share plus 10x $12,304 the pre-tax earnings of the operating businesses.

The upside/downside ratio for the stock is now very favorable as it has 47% upside to hit my estimate of intrinsic value one year from now ($308,000), and only 11% downside to 1.2x book value ($186,601), a floor given that Buffett has a ton of dry powder and would be an eager buyer. (On the first page of his annual letter, he wrote “Berkshire’s intrinsic value far exceeds its book value. That’s why we would be delighted to repurchase our shares should they sell as low as 120% of book value. At that level, purchases would instantly and meaningfully increase per-share intrinsic value for Berkshire’s continuing shareholders.”)

PS–I’m pleased to see that Buffett has finally started including the earnings of Berkshire’s insurance subsidiaries in this number. I (and Glenn and others) have long believed that Buffett was being overly conservative in excluding these earnings because Berkshire’s insurance subsidiaries are so diverse and consistently profitable, so we’d always added about $600/A share to Berkshire’s pre-tax earnings number (about half of the long-term average). It’s good to see Buffett come around to our way of thinking! ;-)

This is what he wrote in his annual letter:

Intrinsic Business Value

As much as Charlie and I talk about intrinsic business value, we cannot tell you precisely what that number is for Berkshire shares (nor, in fact, for any other stock). It is possible, however, to make a sensible estimate. In our 2010 annual report we laid out the three elements – one of them qualitative – that we believe are the keys to an estimation of Berkshire’s intrinsic value. That discussion is reproduced in full on pages 113-114.

Here is an update of the two quantitative factors: In 2015 our per-share cash and investments increased 8.3% to $159,794 (with our Kraft Heinz shares stated at market value), and earnings from our many businesses – including insurance underwriting income – increased 2.1% to $12,304 per share. We exclude in the second factor the dividends and interest from the investments we hold because including them would produce a double-counting of value. In arriving at our earnings figure, we deduct all corporate overhead, interest, depreciation, amortization and minority interests. Income taxes, though, are not deducted. That is, the earnings are pre-tax.

I used the italics in the paragraph above because we are for the first time including insurance underwriting income in business earnings. We did not do that when we initially introduced Berkshire’s two quantitative pillars of valuation because our insurance results were then heavily influenced by catastrophe coverages. If the wind didn’t blow and the earth didn’t shake, we made large profits. But a mega-catastrophe would produce red ink. In order to be conservative then in stating our business earnings, we consistently assumed that underwriting would break even over time and ignored any of its gains or losses in our annual calculation of the second factor of value.

Today, our insurance results are likely to be more stable than was the case a decade or two ago because we have deemphasized catastrophe coverages and greatly expanded our bread-and-butter lines of business. Last year, our underwriting income contributed $1,118 per share to the $12,304 per share of earnings referenced in the second paragraph of this section. Over the past decade, annual underwriting income has averaged $1,434 per share, and we anticipate being profitable in most years. You should recognize, however, that underwriting in any given year could well be unprofitable, perhaps substantially so.

Whitney Tilson – Charlie Munger’s 2016 Daily Journal annual meeting

3) I recorded and had a transcript made of Charlie Munger at the 2016 Daily Journal annual meeting – see attached. Enjoy!

Whitney Tilson – A hedge fund manager helped save Siberian tigers

4) I usually get attacked anytime I go public with a short idea (just ask my assistant – she no longer picks up the phone unless she recognizes the number; and here’s an email I got yesterday: “I’m mortified that an avid reader of Buffett and Munger like yourself is responsible for conclusory, bombastic, fear-mongering propaganda surrounding Lumber Liquidators. You may end up being right in your conclusions, but your analysis is light years removed in quality from your role models.”). So it’s nice to read an article like this:

But the best thing about this case is that it will slow the rate of deforestation in the critical habitat of the Russian Far East. So next time you see a wild Siberian tiger in a photo or on television, spare a kind thought—unlikely as it may sound—for a hedge fund manager. Tilson has moved on to other stocks. But I’m betting that this case will keep both him and Zhou on the lookout for bad environmental practices as one more clue to stocks worth shorting.

Whitney Tilson – Test drive of the Tesla Model X

5) I published an article last week about my test drive of the new Tesla Model X. Here’s the summary:

  • Last week my wife and I test drove the new Tesla Model X SUV, mainly because we’re in the market for a new car but also for investment research purposes (though I currently have no position in the stock).
  • It is a spectacular car: it looks great, is quite compact for an SUV with a third row, and the inside is very cool and stylish – with the huge windshield and falcon-wing doors, it feels like being a spaceship.
  • It is likely the only car that might persuade us not to upgrade to the new Volvo XC90 hybrid, which says something given that we’ve only driven Volvos for nearly two decades.
  • I did find some negatives: it’s very expensive, the third-row seats are very cramped and I’m not sure the falcon-wing doors are very practical.

Whitney Tilson – The carried interest loophole

6) I’m quoted in this article in the NY Times about the battle over closing the carried interest loophole moving to the state level (which is problematic for a variety of reasons – it needs to be fixed at the federal level, but that doesn’t appear likely so moving to the state level is an interesting strategy):

“It is not just ridiculous and unfair, it is the kind of thing that has led to the rise of Donald Trump,” said Whitney Tilson, a hedge fund manager and member of the Patriotic Millionaires, who has long opposed the tax provision despite personally benefiting from it.

“When you tell the average person what’s going on here, it makes them so mad they can’t see straight,” he said. “They turn to someone like Trump who confirms to them that the whole system is corrupt.”

Whitney Tilson – David Rubenstein’s fight to save the carried interest loophole

Coincidentally, the same day ProPublica published this in-depth story about how David Rubenstein, the multi-billionaire co-founder of the Carlyle Group, has led the (so-far-successful) lobbying effort to keep the loophole open – and cut his tax bill by millions (tens of millions?) of dollars annually…

Until recently, relatively little attention had been paid to one source of Rubenstein’s wealth, which he has quietly fought to protect: the so-called carried-interest tax loophole. The tax break has helped private equity become one of the most lucrative sectors of the financial industry. Since the end of the recession, private equity has reported record profits, and at least eighteen private-equity executives are estimated to be worth $2 billion or more each. And during the current Presidential campaign, with its populist themes, the loophole has become a target among Democrats and Republicans alike.

…Barack Obama, during his first Presidential campaign, pledged to reform the tax on carried interest and, in 2012, went after Mitt Romney for having enjoyed its benefits as the co-founder of Bain Capital. This year, Bernie Sanders, Hillary Clinton, and Donald Trump have all attacked the loophole, often using hedge-fund managers as the rhetorical target. As Trump put it in August, “They’re paying nothing, and it’s ridiculous. … These are guys that shift paper around and they get lucky.” Jeb Bush, who made a foray into private equity in 2014, also called for closing the loophole during his ill-fated campaign. Private-equity partners argue that their tax treatment is justified under the tradition of encouraging risky business partnerships and is necessary for their industry to flourish. So far, the partners have won out: despite the rise of anti-Wall Street sentiment after the 2008 financial collapse, the loophole has withstood every effort at reform.

… Of that $140 million in pay, $134 million came from the firm’s share of its investors’ profits. The filings make it difficult to determine the exact distribution, but industry experts say that at a large firm like Carlyle three-quarters of a partner’s pay typically comes out of carried interest. By that calculation, the loophole would have saved the partners about $20 million each, in 2011 alone. Over the next four years, each partner’s savings would have amounted to more than $50 million.

… In June of 2007, Levin produced a more sweeping bill, which became the model for future reform attempts. He called for closing the loophole on the profits of all private-equity partnerships. The capital-gains break would still apply for those who put money at risk by contributing to a private-equity fund, including the firm’s partners, when they had invested their own money. But all income from managing the firm’s assets would be taxed at ordinary rates. The congressional Joint Committee on Taxation estimated that closing the loophole would bring the Treasury $25 billion in revenue over ten years.

The private-equity industry was ready. The biggest firms—Carlyle, Blackstone, Kohlberg Kravis Roberts, and Texas Pacific Group—coördinated operations through a trade association called the Private Equity Council, founded the year before. Together, the council and the individual companies retained twenty lobbying firms for the task. Blackstone spent $4.9 million on lobbying in 2007, working mainly with a team from Ogilvy Government Relations, led by Wayne Berman, a veteran Republican lobbyist. Carlyle also used Ogilvy, along with McKenna, Long & Aldridge, a smaller firm that generally lobbied Democrats. The private-equity lobby could expect strong Republican opposition to tax increases and, among most members of the Democratic House, reflexive support for the loophole-closure bill. But there was an opening when it came to one sliver of the Democratic caucus: Finance Committee members reluctant to raise taxes on big donors in the financial centers they represented. Private-equity lobbyists focused on Chuck Schumer, of New York, and Maria Cantwell, of Washington. Schumer had strong ties to the industry; the private-equity firm Apollo was one of his biggest donors, not far behind Bank of America.

…In May of 2010, when Rubenstein returned to Capitol Hill, he was “the perfect good guy,” a private-equity lobbyist told me. “Unlike these guys throwing themselves million-dollar birthday parties, David is donating the Magna Carta to charity.”

…On June 8, Rubenstein’s cell phone rang as he was speaking to supporters of the Economic Club, at the Phillips Collection. He left the stage to take the call. Among those in the audience was Gary Shapiro, the consumer-electronics lobbyist who was Rubenstein’s travel companion to Japan in the eighties. After a few minutes, Shapiro recalls, Rubenstein returned and said, “That was a senator. That one call just saved us on carried interest.” (Rubenstein denies making this comment.)

On June 30th, in the last of several votes, the package came up three votes short. In the end, Batchelder says, the private-equity lobbyists “ran out the clock.” Since 2010, when Republicans retook control of Congress, prospects for closing the loophole have not revived.

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Whitney Tilson




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