Self assessment Monday: an old letter to a client...

About two years ago I wrote a letter to our foundation client about how we viewed the equity markets. Mike* had sent Bronte a profoundly bearish broker note.

I posted the letter on the blog. The original (reproduced below) can be found at this link.

Dear Mike 

The bear case always sounds intellectually more convincing than the bull case. And it is in this broker note too. Intellectual sounding and convincing. 

But America is still an amazingly innovative country, humans are ingenious and most of the imbalances will sort themselves out. Big cap equities are cheap relative to almost all other assets (especially relative to small cap equities, cash and bonds and to many assets such as commercial property that require leverage). Cash yields almost minus 3 percent after inflation and less post tax. Bonds are scary as hell and yield minus 1% after tax and inflation. 

Big though difficult-to-run companies are at low teens multiples.  Great franchises are at mid-teens multiples.  Tesco (UK) which is a truly great franchise - is at a 14 PE ratio. And the Pound is historically cheap. WalMart and Target - both slightly less good franchises - are at 12 times. The difficult parts of Silicon Valley (eg HP) are well under 10 times PE ratios (and we feel no need to own that one). The less difficult parts of Silicon Valley (Google for instance) are at a high teens PE ratio once you take out the excess cash. We own that. 

Own equities.  Don't kid yourself.  Mega-cap equities are generationally cheap compared to other assets - and certainly compared to the cash/bond/levered asset complex. 

Just don't be blind about it. The places that there have been high returns (Asia, small caps, smaller resource companies) are riddled with fraud. Twenty five years of deregulation and the high levels of innovation mean we have high and rising levels of stock fraud. Fortunately there is much less fraud risk in mega-caps. 

Don't own Australia or the iron-ore-coal-steel complex. It has run too far and has been too easy to make money. Too many stupid/aggressive/greedy people are doing too much expansion. Some of these people are stupid - but they have made much more money than you or me so they must be right!

I can find dozens of reasons to be bearish - but I look at it dispassionately and I am bullish on big caps, and bullish on America. The problems will sort themselves out and the American exceptionalism (decent institutions, free enough markets and a willingness to take risks) will work their magic again. 

Anything that takes you out of real assets (businesses and property that generate real cash flow) and puts you into nominal assets is - with a ten year time-frame - a bad idea. (And why is your personal account any shorter dated than that?) 

Just don't get greedy by buying things you do not understand: you will be ripped off. The underlying fraud level is as high as I have ever seen it.

Oh, and we are also bullish on France and Germany. Old Europe has manufacturing and production power of enormous levels. (Remember what they produced to fight wars? Their productive capacity is very high and Americans have forgotten that. They do engineering as well as anybody. And Germany no longer has a restrictive monetary policy to crush its consumer market.) 

Also the French are in that lovely position of having convinced newly rich Asians that they are the arbiters of good taste. There are few higher ROE businesses. France has played Asia better than America.

We can see plenty of reasons to be bearish - but just the frauds makes our portfolio short enough. Indeed we are plenty short and likely to remain so until I can't find frauds with ease.

Beyond that, there is a lot of pessimism around. It has got to be time to be bullish. We certainly do not desire being 125 percent net long or hyper-aggressive like that - but we will take steps to become incrementally longer. We are if anything too short.

J

At Bronte we have done pretty well in the past two years - and a good part of the reason can be seen in this letter. Still it is worth assessing how we went on a line by line basis.

The starting call - Tesco which we still own has not been great and the turnaround is appearing more difficult. That was a dud.

The Great British Pound is slightly cheaper compared to the USD so that was also a dud. It was a dud we doubled down on by buying a large stake in Vodafone.

Walmart and Target have both been fine investments; up about 40 percent plus dividends. We only owned Target. It is pretty hard to pick the charts apart but we suspect that operationally we might be in the wrong stock. We did not think that income disparity in the US would continue to widen. However it has and a widening income disparity favors Walmart over Target. [Target is just too up-market.] Also we think the very-cheap-very-diversified retailers are the last ones displaced by the web. Walmart is about the safest name in retail.

Hewlett Packard, which we explicitly stated we did not own, was an okay short over that time. We were short but we did not do as well as the chart suggests as we were too aggressive with put options on the premise of an underfunded pension fund – which proved unfounded.

Google which we owned has been a fine stock. However after the appreciation we own much less of it. We were about 7 percent in the stock at $550 and are just above 4 percent in the stock at $870.

Explicitly not owning the Australian iron-ore-coal-steel complex has been a good call. We were short a few iron-ore names. Those mostly worked for us.

Our French and German industrial names have had more than adequate returns. Our French liquor companies have continued to sell a lot of highly priced Cognac in Asia.

The place we have been mostly wrong is on shorting some frauds. We have had irregular wins in this [alas we will not name names]. We have also had a few losses. This is a bull market and bull markets tend not to be the time-or-place for exposing frauds. Still our short book is not an abject failure.  It contains a few wins and very few disasters. The most prominent loss was that we bet hard that the Focus Media acquisition would not close. Focus Media has very funky accounts - but that did not stop a multi-billion dollar acquisition.

The general call to be long big-cap stocks and avoiding Asia/China/Resources was not a bad call. This continues to be our call but we are far less convinced about it now than we were two years ago simply because the price has changed.

Where to now?

I have another person - a close friend - who has just lost her job and wants some financial advice. I would love to give it to her - but I am finding it extremely difficult to write anything as clear and well supported as the advice above.






John

*Mike is not his real name.

Vodafone - Kabel Deutschland: Meet Vittorio Colao - the new Sir Fred Goodwin

Vodafone it seems has made an "informal bid" for Kabel Deutschland.

We have a largish position in Vodafone - some of which we feel compelled to sell. I want to put on the record that I believe this is a nasty diminution of shareholder value and continues the management-board record of incompetence at Vodafone.

I live in Australia - and I have other commitments - so I do not want to run a spill of Vodafone's board myself - but I am happy - indeed eager - to encourage other people to do so.

If any large shareholders in Vodafone wish to organize a spill of the board please contact me. We will be more than willing to participate and will use this blog as a platform to publicize the cause. [We cannot do it ourselves - Bronte is a small operation without sufficient resources to take on a large company.]

For the record though - this blog has only ever taken on one major British CEO. I did it early when I did a series of posts labelled "Sir Fred Goodwin Death Watch". Here is the original one. Royal Bank of Scotland was then still above GBP5 per share. I was also - well before I started this blog - one of the sources for this story in Fortune about RBS.

Vittorio Colao the urbane but seemingly incompetent CEO of Vodafone is the new Sir Fred Goodwin.





John

Self assessment Tuesday: Alan Jones and Facebook... #fail

A while ago I wrote about Alan Jones - a right-wing radio shock-jock in Australia with a well organized Facebook campaign against him.

I did not think Jones could survive the onslaught - new media I thought won.

I bet my business partner $50 that Jones would be chased off air.

I lost - and $50 duly traded hands although I took until today to pay him.

My faith in the power of Facebook to change the world is reduced. Not so keen on FB stock either any more - I find myself using FB less and less...

Worse: my thirteen year old son is not nagging me to allow him a Facebook page.



John

PS. We made a small profit on Facebook stock mostly via selling put options which eventually delivered to us at an average cost in the low 20s. We sold a few calls (and much was called away from us) in the mid to high 20s. I consider this luck. I used to think that FB was a "no brainer" in the low 20s. Not so sure any more.

Please please China - make my day

China is threatening to impose punitive tariffs on European wine exports in a tit-for-tat retaliation for tariffs on solar panels.

Peter Thal Larsen (Reuters - Breaking Views) tweeted that some Europeans would like that.

I would love it.

The Australian wine industry would recover - and get a stronger entry to China than ever before.

And the reduced demand for good French plonk would lower its price - making it cheaper to develop a very refined palate.

Trade wars: bring 'em on.




John

Short selling and misrepresenting the truth - Infitialis edition

I am a short-seller by inclination. Moreover I short mostly frauds and stock promotes.

If you are going to call these publicly you need to be purer than Snow White. Alas I am finding some shorts I respect to be drifting.

I am going to pick on one - Infitialis - an anonymous group. This group (I am assuming there is more than one of them) have been pretty good getting more than a few things right. I read them because some of the analysis is good.

But they are also into the misrepresentation game. This table from a recent report is just slimey:

It purports to show a track record - but it measures everything against the "subsequent low".

Hey - wouldn't you love it if you could be paid performance fees on your long versus their "subsequent high" and performance fees on your shorts versus their "subsequent low"?

This is misleading accounting. Infitialis knows better and should behave better.




John

Practical lessons in assessing exotic risks

I am having a few days of surfing lessons in Bali on the way home from a business trip. Its actually quite productive because I get back from two hours of lessons pretty close to wrecked at 9.30 AM and eat. Then it is work for a bit, have a massage, work for a bit more, go out and be a tourist, eat, work and sleep. I have taken to calling my room at the surf camp "the office" which horrifies the other guests (mostly younger European - especially German speaking backpackers).

Yesterday however was unproductive. I rode a motor-scooter to Tanah Lot - a kitsch bunch of markets and an unusual coastal Hindu Temple. Now riding a motor-scooter in Bali is not risk free - indeed it is exhilarating with risk. However I thought I could reasonably list all the risks.

I could not.

I rode past a horse-drawn cart and the horse lent over and bit my shoulder.

Lesson 1: Its the risks that you can't see that get you. No risk assessment is complete without leaving space for what Donald Rumsfeld called the "unknown unknowns".

Anyway a quick perusal of the internet raises my alarm. Bali was rabies free until 2008 when what was probably a single rabid dog came from Java. Bali being Hindu has dogs roaming around - symbols of good luck. They would not be tolerated like that in most of Moslem Indonesia. There have been well over 100 deaths from rabies in the past few years in Bali. A tourist recently died after being bitten by a monkey.

A further perusal of the internet suggests that it is possible to get rabies from horses - indeed several cases have been confirmed in Canada. Horses it seems are curious creatures and have been known to walk up to strange-acting foxes leaving them vulnerable.

After some advice from some regular Bali goers I wind up at the Bali Clinic in Seminyak (a suburb of the tourist-and-flesh haunt of Kuta). This clinic is run by a mix of Western and local trained doctors and the triage process sends infectious disease cases to one of the local doctors trained at Sriwijaya University in South Sumatra. Now I know nothing about that school and little about South Sumatra other than that it is a well known Petri-dish of infectious tropical diseases (and some very good surfing). My guess is that the average doctor coming out of a university in Sumatra knows more about infectious tropical diseases than all but a handful of Harvard graduates.

So with some discomfort I conclude I am in the right hands.

The doctor sends me home. He is aware that rabies is transmitted by horses sometimes (but rarely) in North America. He is also aware that bats are a vector in some parts of the world. But to his knowledge there has never been a case of rabies in Indonesia from any animal other than a dog, a cat or a monkey. He does however clean out the wound and gives me the expected superficial iodine treatment.

The doctor is almost certainly right. Indeed I would put the chance of him being right at over 99.99 percent.

But if he is wrong I die.

This is a risk I hate taking. Every piece of my being hates taking this risk. In financial markets if you take a risk no matter how seemingly small where an outcome is total failure if you are wrong and you are taking it at the advice of a so-called expert you are likely to blow up.

Partly that is because financial experts exist to make medical experts look good. And it is because financial experts are conflicted in a way that medical experts are not. Indeed it is often because most financial experts are really just salesmen selling you the risks that their employers do not want to take.

Finally it is also because financial risks are distributed so abnormally and in financial markets you take them repeatedly - day-in-day out. Where I only got bitten by a horse once. And things you do repeatedly will get you in the end - but things you do only once probably will not if the risk-level is low enough. If you get into the habit of taking repeated wipe-out risk in financial markets you will eventually be got. I guess if I got into the habit of being bitten by strange animals in Bali I would eventually be got too.

But here I am, lying in the "office" in Bali taking precisely a risk that I promise my clients I will never take: the risk of blow-up on the assurance of an "expert".

Maybe this is the hypochondria of exotic risks. I am flying home with Garuda Airlines - and some will tell me that is an unacceptable risk too. They are now quoted as an airline with a "much improved" safety record. Whatever. It is a plane. I am in the hands of "experts" and I do it all the time.




John

Spark Networks and the strange failure of sex-starved Jewish computer science undergrads...

Whitney Tilson suggested Spark Networks - a dating company - as a long at a value investor forum recently. For the life of me I could not fault it. (Here are some details on Whitney's presentation...)

Spark owns one of the truly great franchises in online dating - JDate.com. JDate - a Jewish Singles dating network is utterly entrenched in its community - mums buy their daughters subscriptions - at least then the boy will be Jewish. I know several users - people who would not consider using another site. A subscription to JDate is a rite-of-passage almost as important as a bar or bat mitzvah.

JDate has been around for a long time - and still goes strong.

I suggested the stock to a friend (who probably wishes to remain anonymous) and here is what he said:

I cannot think of a sector more likely to be disrupted in any industry. 

The thing about dating is that the lifespan of a dating person is roughly 18-25 years old (or at least that will always be the median so that demographic will set social norms, even for 40 year old divorcees). So you are dealing with people who live and breath technology and 'live' for only seven years. 'Science advances one funeral at a time' same with tech but here everyone dies young. So the base rate of innovation and cultural evolution is super high. There is a huge backlash against static dating pages as they are inaccurate (i.e., everyone loves travel, hiking no one says they love dungeons and dragons) ; every girl finds the one amazing photo of themselves.  

Secondarily, you are at the beating heart of the mobile revolution. Dating requires physical proximity so there are a wave of companies trying to do stuff like meetups of 4-6 people for a drink and then they can assess each others dating potential.e.g., www.grouper.com (one could do six Jewish people meeting up too). 

Thirdly - the over representation of Jewish entrepreneurs is insane- Ballmer. Zuckerberg, Page and Brin etc. Zuckerberg only invented FB to get a date! You are literally betting against every sex starved Jewish computer science undergrad. Bad bet.

My friend is almost certainly right - at the end a bet on Spark Networks is a bet against every sex starved Jewish computer science undergrad (SSJCSU) and that is likely a very bad bet. Flatly stupid even.

But so far legions of SSJCSUs have not succeeded in knocking JDate off. Sure they invented Facebook - but the original JDate franchise is still there - robust through all of this. I am sure that some SSJCSUs have tried and indeed are still trying.

So why does JDate still exist? Why this strange failure?



John

An undisclosed cause: Mr Mulacek and Interoil

Today Interoil published a solicitation of proxies. Buried in this - about twenty pages in - is the following extract regarding the recent resignation of Mr Mulacek - the CEO.

Phil Mulacek – Chief Executive Officer 

In February 2012, we entered into an employment agreement with Phil Mulacek as then Chief Executive Officer. No contract had previously been in existence governing our employment relationship with Mr. Mulacek. The employment contract provided for an initial three year term and for automatic one year extensions thereafter in the absence of notice of termination from the Corporation.

The employment contract provided that if during the term of employment Mr. Mulacek's employment was (i) terminated by us except for "Cause" before or after a “Change of Control”; (ii) terminated due to "Disability"; (iii) terminated by him for "Good Reason"; or (iv) terminated within 3 years following a “Change of Control” of the Corporation, then Mr. Mulacek would be entitled to be paid, in the aggregate and within 30 days, (a) a lump sum amount equal to $3,600,000, (b) all accrued and unused annual leave which leave had accrued at the rate of 60 days per year from the commencement of the employment agreement, (c) an amount equivalent to 365 days’ paid annual leave as a “Foundation Leave Benefit”, and (d) an annual bonus amount equivalent to 50% of Mr. Mulacek’s base salary pro-rated from the commencement of the calendar year until the date of termination.

Payments were subject to certain conditions including, (i) provision by Mr. Mulacek of a general release to the Corporation in an agreed form within 21 days of termination, (ii) not competing with the Corporation’s business or soliciting its employees for 90 days after such termination, and (iii) maintaining confidentiality of the Corporation’s “Confidential Information”.

In the event of Mr. Mulacek’s death during his employment under the employment contract, his estate beneficiaries would be entitled to receive a lump sum payment of $3,600,000, together with any other accrued and unpaid benefits existing at his death.

We were permitted to terminate Mr. Mulacek's employment contract for "Cause". Cause includes wilful neglect or misconduct resulting in material damage to the Corporation, wilful and repeated refusal or failure to perform or wilful disregard of his duties, conviction of any felony, acts of fraud, embezzlement or misappropriation, conviction for discrimination against or harassment of any employee, or breach of the covenants in the agreement. 

Mr. Mulacek retired as an employee of InterOil effective 30 April 2013.

So what "wilful neglect or misconduct resulting in material damage to the Corporation, wilful and repeated refusal or failure to perform or wilful disregard of his duties, conviction of any felony, acts of fraud, embezzlement or misappropriation, conviction for discrimination against or harassment of any employee, or breach of the covenants in the agreement" permitted Interoil to terminate Mr Mulacek's contract for cause?

That is of course interesting - but this is downright peculiar from the same document:

Election of Directors
Our Articles of Continuance provide that we must have a minimum of three and a maximum of fifteen directors as determined by a resolution of our Board. The number of directors is presently eight. Directors elected at the Meeting will serve until the next annual meeting of Shareholders or, if earlier, until they resign, are removed or are disqualified. The term of office of each of our current directors who is not re-elected will expire at the Meeting.

The Board has set the number of directors to be elected at the Meeting at eight. Management of InterOil proposes to nominate each of Gaylen Byker, Phil Mulacek, Roger Grundy, Roger Lewis, Ford Nicholson, Sir Rabbie Namaliu and Samuel Delcamp (each of whom is currently a director), and Sir Wilson Kamit, as directors of InterOil. Mr. Christian Vinson, currently a director, and also Executive Vice President Corporate Development & Government Affairs, has indicated his intention to retire as an employee and director of the Corporation and will not seek re-election as a director at the Meeting.

It will be interesting to see how these observations from the same document are reconciled.






John

There is of course a possibility that the words "were permitted" do not mean what they appear to mean. Indeed this is almost the only way I can reconcile the two observations above.

J

Charlie Ergen, patriot, scoundrel, thief: some comments on the Softbank vs DISH battle for Sprint

It seems fitting that the best case that Charlie Ergen and DISH can muster for their bid for Sprint is false patriotism. Softbank they say will be a national security risk. Fitting because Samuel Johnson warned us almost 240 years ago that patriotism is the last refuge of the scoundrel - and Charlie Ergen is a scoundrel.

The misdirection from DISH was from the beginning. Here was the pitch for the DISH offer from the beginning:

The case for the DISH's offer is that it offers $4.76 per Sprint share in cash plus 32 percent of the surviving company. Softbank by contrast offers $4.03 per share in cash plus only 30 percent of the surviving company. 

More cash and a larger proportion of the surviving company - what is not to like about that?

Calling Charlie's bluff on this - plenty actually. You see the surviving company in the Softbank case is Sprint after Softbank has injected $8 billion into it. It is a highly credible competitor for AT&T or Verizon. 

And the surviving company in Charlie Ergen's example is a highly levered beast called DISH-Sprint. DISH Sprint will be bereft of cash and loaded with debt because the cash part of the offer comes largely from leverage.

So it is worth understanding what DISH is.

DISH is a second-tier satellite provider that lost the battle for quality subscribers to DirecTV. Charlie always had an inferior offer based on low cost - when DirecTV had The Sunday Ticket, and was first to market with high definition and other quality-improving features. The Sunday Ticket was a clear - albeit expensive differentiation - it allowed you to watch your home team NFL game even when you did not live in your home town - a great offer in a country with as much upper-income job mobility as the USA. That combined with relatively poor service and lack-of-speed with high-definition meant that DISH found itself caught in a low average revenue per user (ARPU), low growth world. 

Until Charlie hit upon a new business model. The Hopper.

The Hopper is a standard personal video recorder (PVR) attached to the satellite receiver - however it records live the whole of prime time television every night. It then allows you to watch the TV with the advertisements removed for you. To quote DISH's website:

Hate commercials? DISH created commercial-free TV so you can save an hour each night! Now you can instantly skip commercials in recorded primetime TV. Only DISH gives you ad-free TV with the Hopper®.

What an offer - the TV you were going to watch anyway without those pesky little adverts. 

But there is of course a problem: the TV networks did not agree to this. Indeed this is as much a threat to the business of commercial TV (which is still advertising supported) as Napster was to the music business. It is thievery, nothing more. And all four networks are suing DISH for this. You can read the story in The Hollywood Reporter if you wish under the unsurprising title of Charlie Ergen is the most hated man in Hollywood.

The Hopper has done wondrous things for DISH. Subscriber numbers are growing sharply after stagnation. The question of course with the Hopper is how does it end? Does it end with Charlie having to stop it after lawsuits, or some legislative change or the death of commercial TV all up. Either way it looks to be an unsustainable advantage built on an unethical and possibly illegal business model.

It is small wonder Charlie is in the game of diversion. He claims his offer is superior but he is offering crappy DISH stock and is diverting with Patriotism in the time honored method of scoundrels and thieves.

And he is doing it for a reason. He doesn't want anyone looking at DISH (and hence DISH-Sprint) too hard. Because unethical and arguably illegal businesses should trade at a discount - and - dear Sprint shareholders - you should not accept stock in one in exchange for your perfectly good phone company.

John

PS. Disclosures - Bronte owns both Sprint and Softbank. I have not communicated with anyone from Softbank - but Masa Son, if I am in Tokyo you owe me a sake. 

Our big holding is in Softbank.

The end game for Universal Travel: Ms. Yan, 47, has had many years of experience in financial engineering

Universal Travel was the first Chinese reverse merger company I mentioned on this blog. Here is the original post (Travelling Through China)...

The company has since collapsed. It traded up after my original post - something that seems amazing until you work out that an elderly and formerly rich retired car dealer in the Central Valley of California (a man since deceased) spent almost $10 million dollars buying shares.

Those shares are down 98% and the charities that man left his money to wound up nearly empty handed.

Universal Travel's dynamic CEO Jenny Jiang has since resigned. You can see her dynamism in this now classic film of her ringing the opening bell of the New York Stock Exchange:




The 8-K announcing Ms Jiang's resignation also announced her (temporary) successor - a Ms Yan - who used to be the Finance Officer and also the Chief Operating Officer.

Here is what they say about her:

Ms. Yan, 47, has had many years of experience in financial engineering...

So now they tell us...




John