Business

Whitney Tilson – There Is A 28% Chance Of Brexit By The End Of April

Whitney Tilson’s email to investors discussing short & distort?; a short-seller’s email; Tesla’s VIN gap; chance of Brexit; Do You Pull the Parchment?; question 5.

Whitney Tilson chance of brexit

1) A thoughtful, in-depth look at a fascinating case study that raises important issues: Short & distort? The ugly war between CEOs and activist critics. Excerpt:

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The stand-off reflects a broader debate over how to balance the desire to keep public companies accountable with concerns over market manipulation.

Short selling, said to be as old as stock markets, used to be a low-profile affair where bearish investors relied on the media, analysts or regulators to take the lead in exposing over-valued companies. New tools such as Twitter and Seeking Alpha changed that, creating a small but prominent group of brash public activists.

My view is that the rise of short sellers who are willing to go public with their work is, overall, an incredibly healthy development for our markets.

Might a few of them be spreading information that they know to be false and then trading around it to try to make a quick buck? Sure – though this would be insane in light of the risks.

But so what? This is a drop in the ocean relative to the FAR bigger problem of CEOs lying to investors, trying to pump up their stocks so they can cash in. That’s what the SEC should focus on…

2) Speaking of short sellers, in Thursday’s email, I wrote:

A friend forwarded me a 33-slide presentation on Tesla (TSLA), Detecting “Potential” Fraud in Real-Time, that Tom Bachrach of PFH Capital gave on Tuesday to UPenn Wharton students. You can download it here.

I don’t know him or his firm, but it’s an outstanding piece of analysis, especially the forensic accounting part that begins on page 17, which captures why I think there’s at least a 50% chance of significant fraud at the company. Pay particular attention to the “VIN Gap” he discusses on slides 28-29.

[For more on Tesla's VIN gap, see this thread by @TeslaCharts.]

In response, Tom sent me this nice email, in which he shares some wise thoughts on shorting and options (as always, shared with permission):

Hi Whitney,

This looped its way back to me. Honored you enjoyed the Tesla presentation!

I wanted to reach out and thank you. Your work has been very influential in my development as an investor, most recently your posts on short selling last year. The only point I'd contend with regards options. You noted:

"Many investors think they’re mitigating risk by buying put options on a stock rather than shorting it because it reverses the math: gains are theoretically unlimited, while losses are capped at 100%. While this is true, you now have to be right on both the stock and the timing. It’s hard enough to be right on one, much less both, which is why most options expire worthless. Owning something that is likely to go to zero isn’t my idea of mitigating risk." (Source: https://seekingalpha.com/article/4166837-lessons-15-years-short-selling-veterans-advice)

I would add that timing is just as critical when shorting given cost to borrow and (more importantly) path dependency / risk management. My most successful ("lucky") short was Valeant, which I put a position on around $230 in summer 2015. I knew people who put their position on around half that price a year earlier... and yet they didn't make money because they were partially covering the position a year later when it had doubled to manage portfolio exposure. Meanwhile, I was rewarded for being dumber (it took me at least a year longer to find the trade) and luckier (there was no reason my timing had to work in Valeant's case). My experience with Valeant is actually one of the reasons I don't short anymore, i.e. I only use options.

To me, the trick with options is... they almost never make sense because they cost too much... but occasionally they are wildly mispriced deep out of the money (e.g. Tesla) because the market is still using Black-Scholes in a situation that is not even close to a "normal distribution". Those situations are rare and position sizes have to remain small given the high risk of a zero at expiration, which is why I am essentially a long-only investor these days. But with options, I never have to lose sleep trying to decide if I need to hedge a short moving against me at a price I now think is even more overvalued. (I avoid leverage for similar reasons.)

Thanks again for all the wisdom you've passed along (including your contributions to Poor Charlie's Almanack which is one of my " investing bibles")... and also for setting an example for how hedge fund managers should represent our field.

Kind regards,

Tom

PS -- I loved Reed Hastings' 2010 open letter to you. Last year, I sent it to Trupanion (TRUP) when they started aggressively engaging a short (threatening legal action, etc) as an example for how to respond if they feel the necessity. Don't think they listened and I took the whole situation as a red flag for Trupanion.

3) The Brexit train has been picking up speed in the past week. There are only three possible outcomes: Britain leaves the EU with a deal, without a deal, or doesn’t leave. The cognoscenti continue to believe that Brexit is a done deal – the only question is how. But given: a) the likely disastrous consequences of a no-deal exit, and b) I see no deal that both the EU and the British parliament would accept, that leaves only option 3. Thus, I think the UK will eventually revote and abandon this terrible idea. Here’s a NYT article about a large march in London calling for this: Angry Over Brexit Stalemate, Huge Crowds March in London to Demand Second Vote

(If only the stupid Brits would listen to Don Jr. – LOL! Britain is in turmoil — but Don Jr. can save the day)

Here’s a good article in the Washington Post on the topic by Nick Cohen, a British author, journalist and political commentator, on what a disaster Brexit has already been: The quest for Brexit has killed Britain. Excerpt:

It is anyone’s guess what will happen next. There’s talk this week that perhaps May’s withdrawal agreement will pass Parliament on the third or fourth attempt, but parliamentary procedure might prevent her trying again. No one knows. Parliament said on Thursday it is now prepared to ask the E.U. to extend the deadline for Britain’s departure beyond March 29. The E.U. is under no obligation to agree. Even if it does, what would be the point? There is no consensus on what we should do next. Britain is deadlocked, and the catastrophic possibility of the country crashing out of the E.U. without a deal should not be underestimated.

I have no wish to diminish the seriousness of the criticisms against Trump or suggest that he is fit to govern a great country. But Trump will be gone by 2020 or, if the Democrats mess up, by 2024. Brexit gives every indication that it will paralyze Britain for a generation.

One of my readers, Wilber Deck, has a different view, which he shares in this email (along with what the oddsmakers are saying):

(From my email on February 13): My guess is that it is about 10-20% chance of no Brexit, 80-90% for a Brexit, and I would put no-deal at about even with deal, although most bettors put a deal ahead of no-deal. Timing is harder to predict; even if the deal doesn't go through  the House of Commons (I can't see how it could, without changes), this is all part of the negotiation with the EU and May may keep trying for a few more months. 

So far, my prediction is looking good, although this one has been full of surprises and may have more.

At this point, we have betting markets saying 28% chance of Brexit by the end of April (the EU has granted a short extension to 12 April (a 2 week extension), with a longer extension to 22 May if the House of Commons approves the deal that the EU and the UK have negotiated. Markets also suggest a 49% chance of Brexit in the rest of the year, a 12% chance ini 2020, and a 12.5% chance of it being 'Not before 2021', which basically means that there is a 12.5% chance that either the UK leaves in 2021 or later or doesn't leave at all. Importantly, these are not conditional odds, i.e. they are not "If the UK leaves, when will it be?" They are "Will the UK leave or not by such and such a date?"

So odds markets are saying there is a greater than 87.5% chance of the UK leaving before 2021, and a 12.5% chance of it leaving later or not at all.

I think one can logically say that what is now the default option (leaving without a deal by April 12) is even more likely to occur than these odds suggest, by virtue of the following syllogism:

(i) for the EU to extend the deadline beyond April 12, the EU has said the House of Commons must accept the negotiated deal without changes.

(ii) The Speaker of the House of Commons (Bercow) has said that no further votes can be held on this deal unless there are substantial changes, so there should be no vote according to (i)

The only alternative I can see is if the House were to revoke Article 50 altogether, which I am sure the EU would accept enthusiastically (they have been betting the farm on this outcome, even though I think it is unlikely). This might seem to be a no-brainer to people like you who are opposed to the Brexit anyways, and who correctly say that there is a majority of the population who probably wishes the UK could stay in the EU after all this mess, and also a majority of MPs in the House of Commons who are Remainers.

However, the Prime Minister (herself a Remainer) has clearly said that she will not entertain this notion and that she feels her government has been elected on a mandate to honour the results of the referendum 3 years ago. So unless she is somehow overthrown, or resigns, or the House rises up and finds some procedural rule to get around the government, this won't happen.

Also, although a majority of MPs are Remainers, there is a substantial number of them who feel, as May does, that the decision to leave should not now be revisited, so having a majority of Remainers does not automatically mean there is support for revoking Article 50. In addition, polling consistently shows a slight majority of voters are now Remainers, but a hefty majority of citizens don't want another referendum, so they are like their Prime Minister that way, feeling the country should now stick with its decision even if it wasn't their first choice.

Anyways, 3 weeks left and anything can happen. Funnily enough, the odds are about the same as they were 6 weeks ago (28% chance of Brexit before April 30, as opposed to 30% 6 weeks ago when I made this prediction), but I think the scenario of accepting the deal is pretty much dead, as is the perspective of a better deal or an extension beyond a few weeks. I'm not betting but that's where my money would be.

4) Returning to my favorite topic of the past week, this article in the NYT, ‘Do You Pull the Parchment?’: Students Caught Up in College Admissions Scandal Now Face a Reckoning, discusses the difficult issue of what to do with the children of cheating parents. If the students knew, of course expel them immediately. But what about the ones (most of them, I assume) who didn’t know and are probably thriving at their schools?

To me, the answer is clear: while expulsion may strike some as overly harsh, I think it is the only correct course of action, for reasons outlined in the article:

…some ethicists said there was a case for expelling the students who benefited unknowingly from their parents’ machinations.

“It’s pretty common in the law, and it coincides with moral intuitions: If you’re the unwitting beneficiary of a fraud, you don’t get to keep the benefits,” said Brian Leiter, director of the Center for Law, Philosophy and Human Values at the University of Chicago, who has posted on his philosophy blog, “Leiter Reports,’’ about the scandal.

And children, Professor Leiter said, share a common interest with their parents. Allowing them to acquire a prestigious college degree would reward their parents’ behavior, even if they had been unaware of it.

5) Here's question 5 of 12 to ask before you tie the knot:

Is she intelligent and intellectually curious? Do you find her interesting?