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Whitney Tilson On His Favorite Shorts: Herbalife, EXACT Sciences, Wayfair

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Whitney Tilson on Wayfair, World Acceptance, The siege of Herbalife & his response, Herbalife’s disclosure games, An open letter to managing editor, Fortune Magazine Re: Herbalife and Tesla Motors bear case Below is an excerpt from an email which Tilson sent to investors.

Whitney Tilson discusses his short positions

1) Despite largely exiting the shorting business a year ago (too much time and energy for a one-person operation) and now holding fewer than 10 short positions, I’ve made nearly 800 bps on my short book this year – a good portion of that LL, but also nice contributions from WRLD, EXAS, UNIS and my newest short, Wayfair (W), which is already down 24% from where I shorted it three weeks ago, but still has a long ways to fall. For more on W, see these articles:

2) In addition to W, my favorite shorts today are:

i. EXACT Sciences – click here to see the presentation I gave on it at last October’s Robin Hood Investor’s Conference; it’s down 20% since then, but I don’t think there’s ever been a better time to be short it;

ii. World Acceptance – the stock has collapsed (see chart below), but I think there’s a good chance it’s a zero so I’ve been adding to my short on the way down (see attached for an update I wrote on it in the latest issue of Value Investor Insight; click here to read the original two articles I wrote about it in late 2013; and click here to sign up for a free trial to Value Investor Insight); and

iii. Herbalife

3) HLF is the only short position that’s hurt me this year, rising nearly 50%. But I’m not the slightest bit concerned, as I think one or more regulators are (finally!) about to drop the hammer on the company, for a variety of reasons, including the following:

  • In Q1, HLF spent $2.9 million on “Expenses incurred responding to attacks on the company’s business model” and $2.1 million “Expenses related to the FTC inquiry.”
  • In Q2, these amounts soared to $4.8 million and $3.7 million, respectively, up 70% cumulatively.
  • Note also that in Q2, the language changed to “Expenses related to Regulatory inquiries” (rather than “..to the FTC inquiry”), implying that the company is incurring meaningful costs not only responding to inquiries from the FTC, but also from other regulators as well.

When regulators act, I expect HLF’s stock to do what WRLD’s has done since it’s become clear that the CFPB is going to rein in this rogue company – here’s WRLD’s stock chart in the past six months:

Whitney Tilson: Bill Ackman’s “siege of Herbalife”

4) Speaking of HLF, Fortune released a 12,000+ word story this week about Bill Ackman’s “siege of Herbalife.”. The story is highly biased and unworthy of an outstanding publication like Fortune, which is unfortunate but not surprising I suppose given that Fortune’s audience is corporate execs, who don’t like activists or short sellers. (The story also shows the political shift under the new editor I hear.)

Here are my comments on it:

  • I didn’t find any major new revelations, but it covers the history of HLF, Michael Johnson and Ackman’s involvement quite well.
  • While the article is filled with vivid, detailed stories about Johnson and Ackman, there isn’t a single interview with a Herbalife customer or distributor, whether satisfied or not. This is inexcusable. It would have brought the debate to life to talk to some average folks, especially those who claim that Herbalife has victimized them. I’ve learned that the reporter spoke with a few, but decided not to include their stories – I guess figuring Fortune’s readers don’t care about Latinos, particularly undocumented ones, being bilked out of their life’s savings. So much more interesting to write about Johnson’s and Ackman’s athletic exploits, right?
  • The article’s bias is evident from the very beginning, both in the title (“The siege of Herbalife”) and subtitle (“destructive activism”).
  • The article states: “Today, through its Casa Herbalife program, the foundation runs 101 orphanages in 51 countries.” There is no better example of how the company lies (it was no doubt the source for this statement) – and how sloppy, gullible and biased the reporter was. In fact, Herbalife doesn’t run a single orphanage – rather, my understanding is that it gives the orphanages a blender or two and then donates some product (knowing HLF, it’s probably crap it couldn’t sell or has expired, and the company or distributors then take a big tax break for their “charitable” donation).
  • Here’s another example of the bias and shoddy journalism: the article has the following quote:

“I’ve never heard of short-selling activism in my life,” this investor says…”

What caves do this investor (and reporter) live in? Activist short selling is now so common that it’s a rare day that goes by that some short seller doesn’t launch a campaign (I track this via a subscription service/website at www.activistshorts.com; for a free trial, email the founder, Adam Kommel at [email protected] and use my name).

  • Finally, the last paragraph reads:

That, in turn, makes one wonder whether hedge fund managers with outsize egos, reputations on the line, and billion-dollar stakes make the best regulators. And whether, on the basis of their private, closed-door deliberations, they should be sentencing public companies to death.

This is ridiculous. First, nobody is claiming that hedge fund managers make the best regulators. This is just the old trope about nefarious, self-serving short sellers. That said, for well over a decade, hedge fund managers as a whole have compiled an extraordinary track record of uncovering frauds, fads and all sorts of illegal behavior – and not a single one has been charged, much less prosecuted, much less convicted (or even accepted a plea deal) for the market manipulation that so many companies cry and whine about. In fact, I think most regulators now welcome short sellers’ tips and information, especially since they don’t have the resources to address even a tiny fraction of the malfeasance out there.

Second, of course the hedge funds are biased, but the biases of the management teams are far greater.

And lastly, the final sentence is the most ridiculous of all: “private, closed-door deliberations”?! I can’t think of any investor in history revealing more about his position and the rationale, data and analyses behind it than Ackman has with HLF. (Ditto for me and LL – you can see all of my public presentations here and the 17 articles I’ve written here.) And while Ackman has expressed very strongly his opinion that HLF is an illegal pyramid scheme that should be shut down, he hasn’t “sentence[ed a] public compan[y] to death” – sentencing is what regulators do. To use a legal analogy, Ackman is a plaintiff who’s filed a case, not the judge who determines guilt and metes out punishment – which is exactly the way it should be.

(Ackman was on CNBC this morning, sharing his thoughts on the article and HLF (click here) and the benefits of activist short sellers, in which he mentioned me and LL, Einhorn and Lehman, and Chanos and Enron (click here).)

Some of Herbelife’s business is clearly legitimate and some clearly isn’t. The question is: is it 90/10 or 80/20 one way or the other? That’s what numerous regulators have been taking a hard look at, and I suspect we’ll have their answer in the near future. I’m confident that they’ll discover that Ackman is right, which is why HLF is my largest short position.

This reminds me so much of MBIA, where Ackman was vilified for the better part of five years before being proven 100% correct.

Whitney Tilson’s rebuttal to Fortune article

5) At the end of this email is an outstanding rebuttal to the Fortune article, in the form of a letter to the editor, which concludes:

One does not get to be a senior editor at Fortune without understanding the power of words. Unfortunately, yet again we have a journalist apparently more interested in the investor-circus than in truly understanding the nature and risk of product-based pyramid schemes. As a result, we get confusing and inconsistent information, misrepresentations of factors important to determine if Herbalife or any MLM company is actually a pyramid scheme (those highlighted by the 9th Circuit Court of Appeals in BurnLounge would have been a good starting point), and casual under-valuing of the true harm done to the many tens of thousands of people who unwittingly believe in a false “opportunity” presented by a product-based pyramid scheme.

6) Probes Reporter just published a very interesting report entitled Herbalife’s Disclosure Games. The most important revelation is that HLF bull Tim Ramey’s Freedom of Information Act request about HLF with the SEC, which came back negative, which Ramey then trumpeted in a report, was flawed – in fact, Probes Reporter’s subsequent appeal to the Office of the General Counsel of the SEC reveals that the SEC is engaged in “on-going enforcement proceedings” against HLF. Ooops…

The report also documents HLF’s highly questionable disclosure practices and estimates how many people HLF has hired to respond to all of the regulatory inquiries.

While the report is confidential, Probes Reporter posted a video that summarizes it well at: https://www.youtube.com/watch?v=4liu353hylA (3:39)

Whitney Tilson’s Tesla short

7) I thankfully covered my TSLA short long ago, but I thought this was worth sharing. Mark Spiegel of Stanphyl Capital ([email protected]) has been very public with his bearish view on TSLA (here’s one of his articles on Seeking Alpha: http://seekingalpha.com/article/3081566-heres-the-one-way-tesla-can-survive) and gave me permission to share this excerpt from his August investor letter:

We remain short Tesla Motors (ticker: TSLA) which in August reported a disastrous Q2 with $565 million of negative free cash flow and reduced guidance for both 2015 and  2016. The big picture issues for Tesla are twofold:

1) The market is under the mistaken impression that it has significant & sustainable proprietary technology while it doesn’t, doesn’t, doesn’t, doesn’t, doesn’t, doesn’t, doesn’t, doesn’t and doesn’t in batteries and it doesn’t, doesn’t, doesn’t, doesn’t, doesn’t, doesn’t and doesn’t in cars (in fact even Mercedes is reportedly ending its Tesla relationship and will build its electric drive-trains itself), and

2) The company’s management team tells lies, more lies, and still more lies, apparently even lying to collect hundreds of millions of dollars of “battery swap tax credits” to which it wasn’t entitled.

Meanwhile, Tesla cars are now selling so well that in July the company started paying referral fees to people who bring it buyers along with offering discounts to the buyers themselves, and also created a new low-margin “stripper” model.

In June Tesla’s CFO “retired” at age 52 and has dumped nearly all his stock while the VP of Sales & Service has taken a “leave of absence” and is steadily dumping too, as is the Chief Technology Officer.

Also, the company has encumbered nearly all its assets in order to raise much-needed cash. Meanwhile, this month the company did a follow-on stock offering that should provide it with only around five months of additional cash burn, which means it probably will have to raise cash yet again by mid-2016.

Late in the month the stock got a pop from a ridiculously biased rating in Consumer Reports that was eviscerated quite effectively by Holman Jenkins in the WSJ, as someone else earlier did based on CR’s previous reviews.

My target cover price for TSLA remains the high $30s (unless the company enters bankruptcy first), at which point—inclusive of anticipated share issuance between now and then—it would still be way overpriced.

I think he makes a strong argument – and it’s certainly not a long – but I still think it’s a bad short.

Lumber Liquidators LL Tesla Whitney Tilson K12 Questcor Pharmaceuticals QCOR

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