Thursday, November 28, 2013
Whatever. The only people I know that wear Jos. A Bank are the hair-shirted, sometimes proud, always skin-flint value investors who like buy-one, get-two-free offers. Vitaliy Katsenelson is one such person, and last time I spoke he still (again?) owned Jos. A Banks stock and has done very well. I don't always agree with Vitaliy though and I thought his analysis of Apple was peculiar.
I was wanting to do my own due diligence. But travel was a little hard.
So I have a simple request for my readers out shopping for Black Friday. If you pass a Jos. A Bank or a Mens' Warehouse store can you photograph it with your trusty smart-phone and send the photos preferably with time and location to my blog email: email@example.com. I am particularly interested in the rough size of the store and pictures of lots and lots of inventory. It would really help if there were some prices included which gave me an idea of how to work out the retail price of all that inventory.
It is Thanksgiving weekend so I expect the stores to be busy and the stores to be slowly stripped. Crowd photos are not a bad idea either. I don't need the faces - just a sense of the traffic. Jos. A Banks accounts show a lot of inventory - but then so do the shops as per this photo.
This photo is great except I have no idea how to value it all. Stacks and prices are the goal.
Wednesday, November 27, 2013
But it is far worse.
Today I was mapping out some mining operations controlled by people I believe to be fraudsters. I saved a Google map and by default Google made this public. This is (a) business critical and (b) as I may be mapping frauds conducted by organized crime might result in death threats or worse.
However my situation is unusual. It is commonplace that teenagers might save a google map so it is available on multiple devices.
Google Plus will make public your children's movements.
Now Larry Page might not be worried about the safety of his non-existent children but many rich people are. Asian billionaires are (justifiably) concerned about their kids being kidnapped and murdered. [It is not uncommon and I know people it has happened to.]
The idea that by accident - and without their knowledge - their movements are made public by Google Plus is frightening.
There will be kidnapping and murder.
I have at least a dozen billionaires that read this blog. Advice: hire someone, change your kids Google privacy settings. Do it now.
Google Plus has clearly overstepped the line here. It will not be long before there are unintended consequences and some enterprising politician somewhere criminalizes part of their business. They have demonstrated that they cannot be responsible adults.
PS. Long Google. Less happy about it every day.
PPS. There has been doubt expressed about this on Twitter.
I wish to prove a point.
I set up a new Google account with the name and disclosed age of a 14 year old girl (Samantha). I saved a map. I did not turn on location or anything - I just saved a map on a laptop.
Just a location at Bondi Beach. Here is the link.
And here is the screenshot shared with the public automatically:
Google should ask themselves who, other than a creep or otherwise perverted person tracks the maps of 14 year old girls? Does this company wish to aid paedophiles? Is that what "don't be evil" means?
PPPS. There has been some discussion via email on how to reproduce the results. It seems that Samantha maps (the ones linked above) are public but they are not indexed. In other words they are very hard to find unless Samantha reveals them. If however she reveals them once (say to share the address of a party) she will reveal all future maps that are public by default. Surprisingly this is true even if she has turned off all location services and set her G+ to maximum privacy.
One correspondent insists my post is inaccurate and inflammatory because Samantha has to reveal her maps once. I beg to differ. How often would a person chose to reveal one map (and otherwise turn location off)? Teenagers would do it all the time I suggest.
In the above Samantha map someone (BronteBoy) has chosen to comment. He has thus revealed all his maps. BronteBoy (who is also me) has chosen to turn all their location settings off. Saved maps are public by default. You can find this by clicking the link above. Note that BronteBoy never made location settings public and has revealed his maps. The average user would have no idea that by commenting on someone else's maps they are giving them access to all their maps.
Thursday, November 21, 2013
I am sitting in an office in out-of-the-way Sydney Australia. I get glorious sunshine and harbour views and a rather good surf beach down the road but alas I don't get to New York for my privileged access to management.
I have to do my own thinking.
And the thing that I am thinking is that I don't understand tile shop's margins. You see this is - at least on the margins - a truly wonderful business.
I compared Tile Shop Holdings to the fattest margin fast-growth retail business I could think of. As a comparison I used arguably the greatest retailer of our age: Louis Vuitton.
Louis Vuitton sells leather handbags and purses and similar luxury goods for absurd mark ups. There is however a lot of selling expense - they need to maintain expensive stores and maintain the image. So you would expect an ultra-fat gross margin and a lot of selling and administrative expense (SG&A) relative to sales.
Also Louis Vuitton has been in the hottest part of retail - selling super-luxury goods to the world's burgeoning elites - especially the Asian nouveau wealthy.
Here (courtesy of the ever useful CapitalIQ) are the last three full years of LVMH's profit and loss statement. The numbers are in millions of Euro.
|For the Fiscal Period Ending||12 months|
|Cost Of Goods Sold||9,917.0||8,092.0||7,184.0|
|Selling General & Admin Exp.||12,265.0||10,304.0||8,815.0|
|R & D Exp.||-||-||-|
|Depreciation & Amort.||-||-||-|
|Other Operating Expense/(Income)||-||-||-|
|Other Operating Exp., Total||12,265.0||10,304.0||8,815.0|
Louis Vuitton has 65 percent gross margins (give or take about a percent) and a 16 to 19 percent growth rate. (These calculations are mine...)
These are astounding numbers for a retailer but they are what you might expect from LVMH given the mega-trend it is riding (along with seriously competent management).
And here are the same numbers - also from CapitalIQ - for Tile Shop Holdings. The numbers in this case are in millions of dollars.
|For the Fiscal Period Ending||12 months|
|Cost Of Goods Sold||49.6||40.3||36.1|
|Selling General & Admin Exp.||94.7||78.4||68.1|
|R & D Exp.||-||-||-|
|Depreciation & Amort.||-||-||-|
|Other Operating Expense/(Income)||-||-||-|
|Other Operating Exp., Total||94.7||78.4||68.6|
|Growth – year on year||20%||13%|
The gross margin here is 73 percent plus or minus a percent or so.
Who could have known that selling tiles in big-box stores in places like Tulsa Oklahoma could have a fatter gross margin than LVMH selling bags that cost pittance to manufacture for thousands of dollars? Note I am talking margin before SG&A.
Tile Shop grows just as fast as LVMH too.
I am puzzled about this. And unlike the top institutional shareholders I don't have access to Tile Shop's management so I have to try and work it out for myself.
And frankly this time I can't.
So I am going to pitch this question at the top shareholders - the ones who warrant a management stopover in New York. Dear shareholders (or readers for that matter) finish this sentence:
I believe that Tile Shop's gross margins are stable and sustainably higher than Louis Vuitton's gross margins because...
I have a further sentence too:
Last week Tile Shop admitted that its largest supplier was an undisclosed related party. This however does not change my belief about the margins because...
Thanks in advance for your answers.
Sunday, November 17, 2013
The current gold-standard in epistemology is Karl Popper's view that all knowledge is provisional - and you are entitled to believe your educated guess so long as it agrees with experiment. However when someone does an experiment that contradicts your "knowledge" you are no longer entitled to your educated guess. Your educated guess goes into the book of failed theories.
To continue to believe your educated guess is non-scientific.
Popperism applies not only to your theories but to your meta-theories - your theories as to how to test knowledge.
A simple example suffices. People - good, clever people, for centuries believed that the only way to determine whether something was right was to look in the Bible. If the Bible supported it then it is right.
Nowadays we have developed several well-tested theories which are in direct contradiction to the Bible (see deep time in geology and evolution for the best examples).
Not only is the creation myth in Genesis falsified but so is the meta-theory that the appropriate test for knowledge is that it is printed in the Bible.
The FDA's meta-theory
During the FDA panel hearing for Lemtrada (an MS drug under development from Genzyme/Sanofi), the panel voted no on the proposition that the trials are adequate and well-controlled, and yes on the proposition that applicant provided substantial evidence of effectiveness of alemtuzumab [Lemtrada] for the treatment of patients with relapsing forms of MS.
The FDA staff asserted that you could not possibly vote no on whether the test was adequate and well-controlled and yes on effectiveness.
In doing this the FDA staff were asserting a meta-theory - the theory that the only test of effectiveness is an adequate and well-controlled test.
I observe that adequate and well-controlled test is something defined in legislation (see here). And that parachutes as a device to prevent trauma and death to people who jump out of planes have never been subjected to an adequate and well-controlled test as defined in the legislation.
Yet we know that parachutes are effective despite the absence of an adequate and well-controlled test.
In other words we have a contradiction to the meta-theory. The meta-theory demands an adequate and well-defined test as the only method of knowledge and the parachute example is a direct counter-example.
The FDA's meta-theory has been contradicted.
However, much to my surprise, and several years after the publication of the famous parachute paper the FDA staff (and some of my blog readers) still asserts their meta-theory.
I have now categorized the FDA staff in the pseudo-science camp - those who - like their fellow-traveller creation scientists - support their meta-theory in the face of direct falsification.
Hopeless. Stupid too.
Saturday, November 16, 2013
That position has worked out better-than-okay. I still have a largish amount of it (though have sold more than half).
Today I learn that Bill Ackman is behind me - at least in the capital structure. He has purchased Fannie Mae and Freddie Mac common stock (stock that is junior to my preferreds).
My interests are now roughly aligned with Bill Ackman.
So to all my fellow travellers (some of whom still own Fannie and Freddie prefs), Ain't it good to know that you've got a friend.
Friday, November 15, 2013
This is the most convincing "hit piece" put out by any short-seller (Muddy Waters included) this year.
However convincing does not mean it is right. I found Bill Ackman's original 300 page presentation on Herbalife to be utterly convincing. I then did my own work and my view is that Ackman is both convincing and wrong.
It is entirely possible that Gotham is convincing and wrong.
At Bronte we have been short Tile Shop Holdings for about a year but in small quantity, the small quantity reflecting both our lack of conviction (our research was not extensive) and the lack of any catalyst we could identify.
Given the stock dropped almost 40 percent on the Gotham report I can't be displeased. Gotham has provided my catalyst.
That said, until relatively recently being short this was not particularly pleasant.
The reason we were short
The reasons we were short only tangentially overlap the argument covered in the Gotham report. This was not an entirely original short either. I have heard the name suggested by several skilled short sellers (as well as some short sellers whose judgement I do not trust).
The main reason we were attracted to the short was that we simply could not envisage an economic case for the business.
The business, bluntly, is super-stores selling very little other than tiles.
We have super-stores for building products - they are called Lowes and Home Depot. And in Australia, and for that matter everywhere else, they have busily put specialist building materials shops out of business. Killed them stone dead.
I could not imagine "destination shopping" for tiles - and hence the shop did not make sense to me.
Businesses that don't make sense eventually get eaten by the competition. That was (and remains) my expectation for the end-game here. I would rather wrestle gorillas than compete with Lowes and Home Depot.
The public short thesis
As I said, this was a short that was discussed from time to time. The widely discussed short case was that Tile Shop Holdings had very large inventory numbers.
Gotham reports them in days sales of inventory - and here I reproduce their table.
Approximately 400 days of inventory in a retail store seems very odd. It seems double-odd in a big-box retailer. The formula for most retailers is to turn the product over very fast (the faster the better) and earn a small margin lots of times over the space. This is the model that emphasizes sales per square foot, asset turns, low pricing.
The conventional model is clearly not the model of Tile Shop Holdings which has a huge amount of inventory, low turns and very fat margins.
We thought very little of the business model (destination stores for something you might buy once a decade). Therefore we were short. We did not think the fat margins were sustainable.
The publicly discussed short-thesis is not entirely convincing. There are models which have very large amounts of inventory with very low turnover but where it all works because the margin is fat.
Plumbing supplies is a good example.
Our house has all matching taps (faucets in America).
Suppose one faucet breaks and I need to replace it.
I would very much like it to match all the other faucets or I may have to change them all.
A plumbing supplier who can sell me a matching faucet, not fashionable for fifteen years and out of production, is a very welcome supplier.
I would happily give him a 300 percent gross margin.
And to get his gross margin he has to stock a huge range of plumbing supplies, and so winds up large inventory and low turns.
It was possible that Tile Shop Holdings was like that. It had a huge range of tiles and relied on people falling in love with particular tiles and the range would allow them an increase in gross margin. Other than looking at shops and querying customers I had no real way of knowing whether the inventory numbers were sensible or not.
The inventory numbers however are worrying. There are several frauds in retailing that have depended on large and faked inventory numbers. One of the most famous of these - famous at least in part because one of the perpetrators talks to short-sellers - is Crazy Eddie. Sam Antar is more than happy to tell short-sellers how he pulled off the Crazy Eddie fraud.
Then along comes the Gotham Report. Here is the show-stopper allegation:
TTS's largest supplier, Beijing Pingxiu, is an undisclosed related company, and accounts for 20-30+% of TTS's cost of goods sold.
Beijing Pingxiu is secretly controlled by Fumitake Nishi. Mr. Nishi is the CEO's brother-in-law and a TTS employee.
Beijing Pingxiu invoices sent to the Tile Shop are directed to Fumitake Nishi. Beijing Pingxiu has no presence in one of its listed addresses, and a minimal presence in another.
Days sales' inventory for FY2011 & LTM 2013 exceed 365 days, at 396 & 414 days respectively.This is a show-stopper allegation because it provides a mechanism to fake the inventory numbers. Before the Gotham Report you might guess that they had faked their numbers but you had no mechanism for explaining how they might have done it. You had nothing auditable. Indeed all you had was a guess.
After the Gotham Report you had a mechanism. That certainly increases the chance that the "fraud thesis" is right.
The company issued a press release denying most allegations but confirming some allegations in the Gotham Report.
Here is the main part of that release:
Tile Shop Holdings, Inc. (TTS) (the “Company”), a specialty retailer of manufactured and natural stone tiles, setting and maintenance materials, and related accessories, announced that earlier today, the Company was made aware of a report which alleges that its historical financial statements may require restatement along with other accounting irregularities. The Company adamantly denies these allegations and believes that the financial statements are properly stated and its business practices are appropriate.
The Company negotiates all inventory purchases directly with each vendor. As is common practice, certain vendors utilize an export trading company, such as Beijing Pingxiu, for sales to U.S. based companies. Other Chinese vendors maintain their own export licensing authority. The Company has been made aware of changes of the ownership of Beijing Pingxiu which were not previously disclosed to the Company. As a result of this disclosure, The Company has suspended its relationship with this entity.
The Company intends to thoroughly investigate this relationship. The Company believes that any issues associated with the ownership of Beijing Pingxiu, or the utilization of other export trading companies, have had no material impact on the economics of inventory purchases.
Further, the report alleges that the Company’s vendors are compensated in some form through stock transfers. The Company can confirm that there have been no issuances or transfers of stock from the Company or inside shareholders to any vendors or to Beijing Pingxiu.
In it the company denies accounting irregularities and confirms that they use intermediate export trading companies to buy their tiles.
Then they sort-of-confirm the show-stopper allegation. They confirm that there is an "ownership" issue with Beijing Pingxiu that were not previously disclosed to the company. It sounds like a related party, but they do not confirm that the related party is the CEO's brother in law (as per the Gotham allegation).
That said, having confirmed an undisclosed "ownership" issue they state that they do not believe this has had a material impact on the economics of inventory purchases. [In the Crazy Eddie case it may not have had an impact on the economics of purchases - but it sure had an impact on the accounting of purchases - but that is a digression.]
Still we now know that someone failed to disclose a material relationship ("ownership") in a major (maybe the major) supplier.
We know there is at least one cockroach. It looks to me to be a very big cockroach.
Actions for the board of Tile Shop Holdings
Gotham allege that the related party to Beijing Pingxiu is the CEO (or at least his family).
If this was not disclosed the board has a problem - they cannot be sure the CEO is trustworthy.
For a board that is a very difficult situation - one I would not envy.
The board should stand the CEO aside - at least temporarily whilst outside lawyers do an investigation.
The company has announced an intention to "thoroughly investigate". There are processes for doing this. And this board has reputable people on it who have reputations to defend - so I expect it to be done.
Thursday, November 14, 2013
Lemtrada had various features that made it hard - if not impossible - to design a proper double-blind test of its effectiveness. [Both Lemtrada and the counter-factual drug Rebif have substantial and identifying side-effects. The patient would know which drug they were on.]
Instead Sanofi/Genzyme designed a test in which the patients were not blind as to which drug they were taking however the people who rated their MS symptoms were blind. [This is the so-called "rater-blind" test.]
On Friday the FDA staff put out an advisory note on Lemtrada which (a) noted the bizarrely nasty side-effects of the drug, and (b) noted some anomalies in the statistics in which Sanofi/Genzyme presented to support the application for approval. This staff note was widely reported (see Bloomberg for an example) and it was thought that the drug may not be approved.
Safety was no surprise. The statistical anomalies were.
Today the FDA Panel heard the case. The best coverage came from Twitter - and I am grateful to Sarah Karlin for her wonderful Twitter account. The panel voted on many things, however I want to highlight just a couple:
Question 1: are the trials adequate and well-controlled?
Vote: 11 no, 6 yes. one abstained.
Question 2: Has the applicant provided substantial evidence of effectiveness of alemtuzumab [Lemtrada] for the treatment of patients with relapsing forms of MS?
Vote: 12 yes, 6 no.
On question #2, after the panel voted, the FDA staff asserted that if you voted no on question #1, you can't vote yes on #2.
The committee chair said they voted yes based on gut feeling which I am not sure is adequate - but the FDA staff assertion is wrong and I believe incompetent. It is perfectly acceptable to say that the trials are not "well-controlled" but there is substantial evidence of effectiveness. I present to you, yet again, the famous "parachute paper".
In that paper Gordon Smith and Jill Pell observe (with appropriate irony) that there has never been a well controlled double-blind study of parachutes as a device to "prevent death and major trauma related to gravitational challenge". Indeed because an adequate and well-controlled test is a requirement for approval parachutes are not approvable.
This is bunk.
We know why a parachute works.
We understand the physics well.
A single person who jumps out of an airplane and lands unharmed with a parachute is a convincing test that parachutes are effective.
Bluntly, you only need double-blind stats when you don't understand the physics.
The FDA staff have (as parodied in the parachute paper) raised their statistical mystique to a cult - as if it were the only valid form of epistemology. But there are other ways of knowing, they are more valid (as per the parachute example) and there is a deep underlying incompetence in the FDA cult of double-blind statistics and in the assertion highlighted above.
We are living in an age where it is possible to have deep knowledge as to how the body works. We know for instance there is a gene which codes for a protein which is necessary in the metabolism of certain selective serotonin reuptake inhibitor drugs and the presence or absence of that gene has effects. Very small sets of statistics that confirm the effects would be valid epistemology just like a very small set of statistics about people who jump out of planes with parachutes would enable you to conclude that parachutes are a good idea if you want to jump out of planes.
I read the statistics paper that the FDA staff put out on Lemtrada. It was not fun reading. It also convinced me that we should be circumspect about both our knowledge and our methods of determining what we know.
Circumspection about epistemological process however is hard for a fund manager. It is even harder for a government department.
PS. I wrote that an interest in epistemology would be used as a criteria in assessing job applicants at Bronte Capital. I was not kidding.
Disclosure: there is a traded contingent value right whose value depends on approval for and sales of Lemtrada [ticker: GCVRZ]. We own a small quantity. We also roughly doubled the position after the FDA staff paper was published.
The content contained in this blog represents the opinions of Mr. Hempton. You should assume Mr. Hempton and his affiliates have positions in the securities discussed in this blog, and such beneficial ownership can create a conflict of interest regarding the objectivity of this blog. Statements in the blog are not guarantees of future performance and are subject to certain risks, uncertainties and other factors. Certain information in this blog concerning economic trends and performance is based on or derived from information provided by third-party sources. Mr. Hempton does not guarantee the accuracy of such information and has not independently verified the accuracy or completeness of such information or the assumptions on which such information is based. Such information may change after it is posted and Mr. Hempton is not obligated to, and may not, update it. The commentary in this blog in no way constitutes a solicitation of business, an offer of a security or a solicitation to purchase a security, or investment advice. In fact, it should not be relied upon in making investment decisions, ever. It is intended solely for the entertainment of the reader, and the author. In particular this blog is not directed for investment purposes at US Persons.