It was the night before Christmas... falsifying Bill Ackman's Herbalife thesis

It was few days before Christmas and Sahm Adrangi (from Kerrisdale Capital) pinged me (on Google Voice) asking if I had an opinion on Herbalife.

I responded: "why bother? Crowded short."

I knew a little about Herbalife. It was a multi-level-marketing scheme (MLM) selling mostly weight loss products. This was a scheme where instead of buying weight loss products from a grocer or a specialist shop I purchased them from a friend. And the friend could make money two ways - either by selling product to me or recruiting me to sell product to other people.

I have long held a distaste for MLMs seeing how Amway used to behave in Western Sydney. Amway sold overpriced crap to distributors who were a collection of no-hopers and recovering drug dealers. (Contra: I also knew a very successful Avon lady... and she convinced me that MLMs sometimes sold useful products well.)

That said, Sahm just told me to listen to the Bill Ackman presentation. Sahm is crazy-smart so if he tells me to listen to something I listen.

Anyway, I unfurled myself on the couch at work for three hours of (Bill's) self indulgence.

Bill Ackman's thesis about Herbalife is that it is a pyramid scheme, hence

(a) illegal,
(b) unsustainable, or
(c) both illegal and unsustainable.

He has several key slides to support this thesis...

First he makes out that people don't really know what Herbalife is. He uses comparable companies being Church & Dwight, Energizer and Clorox.

I confess to knowing few Herbalife products - so this was modestly convincing.

He then - using that piece of rhetoric asserts that Formula 1 is the only $2 billion brand that "nobody has ever heard of".

So far, so good. He does not assert the sales are not real though (because they are). Indeed he acknowledges the company is real and that the gross margins are superior.

Through a process of elimination he shows that the gross margins are not a result of superior product (its a commodity), superior technology (they do not have any), superior R&D (they don't do any) or any of half a dozen other reasons you might have superior margins.

After that he asserts (and then tries to prove) that the gross margin and indeed the whole business comes about because it is a pyramid scheme.

He uses an old Federal Trade Commission (FTC) definition of a pyramid scheme - and it is the definition which we will go with because this determines whether Herbalife is illegal (in the US anyway) and the FTC definition overlaps with what would commonly collapse as a pyramid anyway.

Here is the slide defining a pyramid scheme.

This legal definition is the core to the whole Herbalife story - so I will write it out:

If an organization sells goods or services to the public and the participants in the organization obtain monetary benefits from (1) recruiting new members and (2) selling the organization's goods and services to consumers, the organization is deemed a pyramid scheme if the participants obtain their monetary benefits primarily from recruitment rather than the sale of goods and services to consumers. [Emphasis as per Bill Ackman...]

In summary: real sales to consumers is kosher. Sales to distributors (and not to end consumers) are not kosher. A little of the latter is OK (the distributors do need to have some stock). A lot of the latter is not.

The critical question is how much are sales to consumers.

And here the question arises: what is a sale to a consumer versus a sale to a distributor. After all if a distributor buys the product for their own use they are considered a consumer. If the distributor buys it to sell it (and they are stuck with it) then they are a failed distributor. End consumption is what matters here.

Slide 119 asks this question fairly directly:

To quote:

How much product purchased by Herbalife distributors is actually resold to Retail Customers?

The next slide repeats the now infamous David Einhorn question on a conference call (the one that caused the stock to drop 20 percent). It is a question that Herbalife answered very badly...

Again I will quote because it is critical:

Question #1 from David Einhorn: "First how much of the sales that you'd make in terms of final sales are sold outside the network and how much are consumed within the distributor base?"
Answer: We don't track this number and do not believe it is relevant to the business or investors.

The full text of the Einhorn question and answer session is at the end of this post...

Bill Ackman does not state it - but the question was asked on 2 May 2012.

Anyway this is a terrible answer and left Herbalife open to the Ackman attack because a surprisingly large proportion of the sales are not to externals but to people who are signed up as distributors. Self consumption by distributors is a critical issue and the company said they did not track it.

Three weeks later Herbalife was in damage repair mode - trying to distance themselves from this answer. Ackman puts up several slides dealing with this - a typical one is repeated below...

Again - for completeness I will put up the Ackman highlighted sections...

"...the attempt of Herbalife 101 was to break the distributors into single and multilevel. Why? Because A, it is truly single, and B, nobody questions single-level, knowing that most people who are in single-level aren't in it to make a lot of money. They are in it for part time or it self-consumption. If you go back to the old Avon model, before they were multilevel, right, self consumption, not even an issue. It is not covered on the FTC's website. It is expected."
And later...
I think it has been misrepresented as the product needs to be consumed outside the network, which it does not. A, the FTC said it does not. But B, wehn you think of the 82% of people at single-level, which is, again, that is all they are, it is not even a consideration as a challenge to the model.

Essentially the company eventually answered David Einhorn by asserting that the single level distributors are basically self-consumers - and hence part of the consumption set rather than part of the distributor set.

And this is the critical question. If the single level distributors are distributors without end sales then this is a pyramid. If the single level distributors are really consumers then this is not a pyramid, is legal and probably sustainable.

The company clearly has some explaining to do. What they are asserting is that millions of people sign a 48 thousand word distribution agreement, pay a $55 fee to become a distributor and buy product then just consume it themselves anyway. Bill Ackman clearly thinks this is BS.

The company asserts they do this because if they sign up as a distributor they get a 25 percent discount. It makes their personal consumption cheaper.

Bill Ackman then asks the following (possibly rhetorical) question:

Again to quote:

Why would anyone pay $55 to get a 25% discount when Herbalife products are widely available online for discounts of more than 35%?

Ackman answers this question with the following slide:

Bluntly - and this is the critical step in his argument that "We Believe the Majority of Herbalife's So-Called "Discount Buyers" are, in Fact, Failed Distributors" [punctuation in Ackman original].

About this time Sahm Adrangi pinged me again. It was one of those classic Sahm Adrangi observations - super-smart but I don't think how smart he realized it was.

He said that Ackman's assertion is really funny. He was imagining billions of dollars worth of Formula 1 diet supplements sitting on people's shelves or in their garages unsold. They sell almost two billion dollars worth of Formula 1 per year - on my count roughly 120 thousand metric tonnes per year. Most of that is sold to "distributors" who may or may not be "discount buyers". If they are - as Bill Ackman asserts - "failed distributors" then maybe 50 thousand tonnes of this stuff are building up on shelves and in garages every year.

If that 50 thousand tonne per annum build up is real then Bill Ackman is right.

And if that 50 thousand tonne per annum build up is not real then Bill Ackman is wrong. He is falsified. The whole Bill Ackman thesis falls apart.

We at Bronte are really into our epistemology. We seek things that can falsify our thesis - and if our thesis does not conform to reality then it does not matter who we are (Bill Ackman or Richard Feynman) and it does not matter how smart we are, we are wrong. Indeed here is Richard Feynman explaining process...




Indeed this video (and you really should watch it - visitors by email should go to the blog) lays it out.

You make a guess. You calculate the implications of the guess. If those implications do not square with observation then the guess is wrong.

Ackman made a guess - the guess is that the "so called discount buyers are in fact failed distributors".

The guess implies that there is a 50 thousand tonne per annum build up of Formula 1 on shelves and in garages of failed distributors.

If that calculation does not conform to reality then Bill Ackman is wrong (and it does not matter who he is, how smart he is or how beautiful the thesis)...

Our attempts to observe the 50 thousand tonnes per annum build up...

At Bronte our version of investing nirvana is when we can find theses on which you can make or lose a lot of money. And then peculiarly we can design simple falsifiable tests. Sahm Adrangi (bless his brilliant soul) provided us our test...

Go find (or fail to find) that 50 thousand tonnes per annum build up...

To start I asked some Herbalife distributors (found via the internet) what their stockpile was.

The answers were so small that they could not possibly account for the necessary build up.

But I guess those are the successful distributors as they can be found via the internet.

So I tried to think like a failed distributor.

If I was a failed distributor I might have $2000 worth of this getting old on my shelf. I might (reasonably) want to recover some money. So I would sell it.

Where? Craigs List or Ebay.

If I found lots of desperate distributors - failed ones - selling it on Ebay then Bill Ackman is probably right. If there are no such people then Bill Ackman is wrong. Simple test. And I can do it for any city or country in the world from my desk at home. For example I could use a proxy server and log into Ebay in France and test there. Which is what I did.

Anyway here is an example - Craigs List, Chicago, complete Herbalife listing...

It is a grand total of six people, five of whom present as small time failed customer/distributors and one of whom is trolling for business as a continuing distributor. The small-time distributors have some opened product (as in I started this diet and it was not for me).

I have done this test for many cities - and I simply have not found the level of distress. However if you go to a city with a large Hispanic population you find a lot of adverts. Los Angeles has many but almost all of them are continuing distributors wanting to sell products. This is a typical advert:

This person has been advertising on Craigs List for some time.

There are also adverts pitching that if you "sign up with me" you can have a permanent 25 percent off your Herbalife products...

In other words they are pitching precisely the offer that Bill Ackman (rhetorically) thinks is implausible.

So far I have found nothing like the level of distress that would be implied if Bill Ackman's thesis is correct.

So I looked at Ebay. Linked is a typical seller... the seller has sold well over 2000 Herbalife items, all with a minimum price (typically a 35 percent discount to retail) and over a multi-year period. They often detail their use-by dates - and those use-by dates change over time (suggesting that the product was purchased at dates that also changed over time).

When you try to communicate with one of these sellers you work out the truth. They are higher-level distributors. They buy the stuff effectively at a 50 percent discount (or 42 percent discount) and sell it at a 35 percent discount and thus make a profit. They are not failed distributors. Instead they are discounters gaming the system by trying to capture the bulk of the profits of the chain.

I looked and looked. Honestly I did. And I could find no evidence of large sales at distress - the sort of sales that would happen if there were 50 thousand tonnes per year build up of unsold inventory in the hands of "failed distributors".

And so we have it. Bill Ackman had a thesis. I calculated the implications of that thesis (distress selling on Ebay and Craigs List). This observation did not accord with reality.

Therefore Bill Ackman is wrong. And it does not matter how beautiful Bill Ackman is, how smart he is, how rich he is, or whatever. He is still wrong. And there isn't any room for argument about it.







John

PS. Bill Ackman being wrong does not make the stock a great buy. Indeed Bill Ackman being wrong does not tell me the truth. I can't find the truth with any certainty. I can only falsify ... I have a series of theses about the truth but they are subject of other posts...

There could be one of hundreds of other things wrong with the company (and hopefully those are testable things).

But we can be certain of one thing: Herbalife is not a pyramid scheme in the sense promoted by Bill Ackman. We can take the 300 page Bill Ackman presentation and throw it out. Falsified...

And any journalist (Michelle Celarier) who continues to take Bill Ackman seriously on this issue has disconnected from reality.


J



Appendix - the full text of the Einhorn question and answer session

David Einhorn

I've got a couple of questions for you. First is how much of the sales that you make in terms of final sales are sold outside the network and how much are consumed within the distributor base?

Desmond Walsh

So, David, we have a 70% customer rule, which effectively says that 70% of all products is sold to consumers or actually consumed by distributors for their own personal use. So, obviously, what we've seen with Nutrition Clubs is that we now have visibility for the first time to our customers. You know that we reported on this call for the first time, the number of commercial clubs around the world, which is in excess of 30,000. So that has given us visibility to the tremendous amount of products that are being sold directly to the consumers and we see that as a growing trend in our business.

David Einhorn

So what is the percentage that is actually sold to consumers that are not distributors?

Desmond Walsh

So we don't have an exact percentage, David, because we don't have visibility to that level of detail.

David Einhorn

Do you have an approximation?

Desmond Walsh

So well, again going back to our 70% rule, we believe that it's at 70% or potentially in excess of that.

David Einhorn

Okay. What is the incentive for a supervisor to sign somebody up to become a distributor as opposed to -- if they're just going to consume it for themselves, as opposed to just selling them the product for the markup? How does the supervisor come out better?

Desmond Walsh

Sure. So I think there's 2 reasons for that. So we know from our business today that many of our future supervisors and business builders come in as customers and then they become distributors. So the benefit from a supervisor is the ability for a greater retention of that customer/distributor because they are now earning a 25% discount. The second issue is that it preserves lineage. So obviously, if I sign you up, David, as a distributor, my hope and expectation is that based on the tremendous product result that you're going to achieve, that you will have friends and families go to you and say, gosh, David you look great, what are you on? You're going to respond and say I'm Herbalife and that will encourage you to say, wow, maybe this is a business opportunity I could be interested in. So the benefit for me as your supervisor is one, the discount that would get and therefore, my greater likelihood of retaining you as a permanent customer. And secondly, the hope that at some stage, you will decide to do the business and therefore, that you are already in my lineage and is part of my group.

David Einhorn

But just trying to understand this clearly. If I sell to a customer -- I bought it, I'm a supervisor, I buy at a 50% discount, I sell to a customer and make 50 points if he pays the full price. If he signs up as a distributor and buys it himself, he gets a 25% discount and I get 7 points as a royalty, is that how it works?

Desmond Walsh

No. You will get the other 25%.

David Einhorn

I'll get the 25% plus the 7.

Desmond Walsh

So unless you're earning royalties, you would simply earn the difference. So you're in a 50% discount, you're selling at a 25% discount. And so the difference between the 2 is your profit on that sale.

David Einhorn

Right. So if he signs up as a distributor and buys it for himself from Herbalife, I still get the 25%?

Desmond Walsh

That is correct.

David Einhorn

Okay, good. One last question. When you had your previous 10-K, you disclosed 3 groups of distributors at the low end. You called 29% self consumers, 57% smaller retailers and 14% potential Sales Leaders. And then that disclosure did not repeat in the subsequent 10-K. So I've got 2 questions. First of all, how do you track that and how do you characterize and know which ones are which? And second, why did you stop disclosing that in the last 10-K? Is that something that you've stopped tracking or just stopped disclosing?

John G. DeSimone

This is John. The criteria for grouping distributors into different classes was based off of their volume purchases. And we make assumptions that people below are a certain volume weren't doing the business, they were buying self consumption. And I don't remember the exact amounts but I can get it to you after the call. It's how we delineated between the 3 classes. One of the reasons we took it out of the 10-K is a change in CFO for which to me, I didn't view it as valuable information to the business or to the investors. However, we can easily provide the exact same breakout going forward if you like. I could email it to you and to our investors. Again, I don't remember the exact delineation between the 3 classes but I can certainly get it to you. Our objective is to be completely transparent.

Bronte Capital is hiring

APPLICATIONS ARE NOW CLOSED. We received 270 plus - and we are finalizing a short list...

Now we have hired. Thanks for your interest.

We are a small, fairly rapidly growing hedge fund with a good record and very few staff. More precisely we are a long-value equity fund with an esoteric and successful short book on the side.

Our record is well into the top-decile for hedge funds globally – and we intend on keeping it there. We are idea driven and risk-management obsessed.

We are happier hiring outside the traditional hiring loop. A science background with genuine interest in investment for instance is preferred over investment experience. Some unconventional combinations (computer science and criminology for instance) will be looked on favorably.  

Most - but not all of the work will be directed to identifying short-sale candidates however an interest in more conventional value investing would be useful too.

---------------

Our short book involves mass diversification of frauds, fads and failures with an emphasis on frauds. 

We are looking for one (and maybe more than one) analyst to be based in Bondi Junction (Sydney) Australia. One hire must have high-level computer skills. If we fill that position we may select a second person on a broader skill set.

Our work place is intellectual, playful, casual. A core job requirement is to be able to tell us when we are wrong. We are not looking for sycophants - telling us what we want to hear is of no use if it is not telling us what makes money. There are other organizations where being political pays but this is not one of them.

The successful applicant will however probably be more implementation driven than us. [We are hiring in part to cover our weaknesses!]

You will need to be self-motivated. Hours can and will be long, but clothing casual and if you want to come into work late because the surf is good that will sometimes be OK. Performance and output matters considerably more than face time.

We expect that a successful applicant will eventually be an equity participant in the business.

As we run a global fund from Sydney a successful applicant can expect some international travel.

Our main requirement is for an analyst who is really interested in the stock market and has well developed skills in data management and computer systems development. We aim to develop some very large data sets which will help us identify likely candidates for short-selling globally. We already identify literally hundreds of short-candidates annually and we are currently short over 100 names. The computerisation of this process is our main medium term task. Much of our edge is in knowing what sort of attributes are indications of fraud or weak performance. It is this high level filtering and screening that we need to automate on the short side at this time. This will involve large data bases of relatively low frequency (daily or even monthly close, not ticks) but high granularity (every item on the financial statement, outstanding option positions, cost of borrow, short interest and availability).

Programming skills are a requirement. Experience with technology that allows structured queries and searches on datasets (financial and non-financial) are a major advantage.

A working interest in epistemology is also useful.

Applications by email via the blog email brontecapital@gmail.com - or through our website - www.brontecapital.com.






John

PS. This post will be removed when we have found the right candidate. I have no intention of being inundated with CVs forever.

PPS. I have not taken advice on Australian immigration law but my understanding is that the law requires that I actively try to recruit an Australian and - failing that - I may open the offer up more widely. This is the path that I am taking anyway (pending contrary advice). Remote work is possible - but personally I have been unsuccessful in the past trying to manage it - so it is unlikely.

Fraud/promote shorts versus valuation shorts

Mostly at Bronte we short frauds or promotes. Stuff where the management says X but X is not true. Sometimes X is a stretch (a stretch made by promotional management). Sometimes X is patently false.

Either way we can describe what we do. We find things where the market is deliberately misinformed and hence comes up with inaccurate prices. We think (on reasonable grounds) that we are smarter than a deliberately misinformed market - and we often are.

We can answer the question "what is it that we see that others do not?"

Sometimes (rarely) we do valuation shorts. [We have a few valuation shorts now.]

In a valuation short we are working on the same information as everyone else has. This makes me uncomfortable. There is an arrogance in suggesting we can analyse the information better than anyone else. We find it harder to answer the question of what we see when others don't and hence harder to justify the position at all.

Indeed often we have no idea what the others are thinking and when I do not know what someone is thinking it is hard to justify (or test) the view that they are wrong...

I think this is the explanation for the cliché in short-selling circles that shorting valuation is a poor game.

Anyway - I am uncomfortable because I can't describe my informational edge and I don't like thinking I am smarter than other people (as opposed to better informed than other people).

That is all.






John

Ozymandias and the banks

I read a broker note today which described China's Ozymandian (and bank funded) urbanization program. But then the banks have always lent towards Ozymandias.

Here - framed for irony - is UBS paying Ben Kingsley to read the classic Shelley poem.

Enjoy...

The conflict between managing funds and selling funds

BT Australia - before it was purchased by Principal Financial Group for AUD2.1 billion - was the dominant independent fund manager in Australia. Its position seemingly secured by a very good (albeit aging) record of funds management and an unbeatable sales force. That $2.1 billion was paid in the third quarter of 1999.

And then it all went wrong.

The bellwether for a spectacular decline was the launch of the TIME fund. TIME stood for Technology, Internet, Media and Entertainment. The launch date I believe was 14 March 2000, the exact date the NASDAQ peaked. Here is an article from May 2000 expecting 15-20 percent annual returns.

It did not work out quite that well.

As the 2003 Form 10K for Principal says:

On October 31, 2002, we sold substantially all of BT Financial Group to Westpac Banking Corporation ("Westpac") for proceeds of A$900.0 million Australian dollars ("A$") (U.S. $499.4 million), and future contingent proceeds in 2004 of up to A$150.0 million (approximately U.S. $80.0 million). The contingent proceeds will be based on Westpac's future success in growing retail funds under management. 

The decision to sell BT Financial Group was made with a view toward focusing our resources, executing on core strategic priorities and meeting shareholder expectations. Changing market dynamics since our acquisition of BT Financial Group, including industry consolidation, led us to conclude that the interests of The Principal shareholders, BT Financial Group clients and staff would be best served under Westpac's ownership.

Westpac later largely closed the funds management part of the business.

In three years the business was largely destroyed along with the career and reputation of the then Principal CEO.

The "retrospectoscope"* is a fine instrument - but it is still obvious what happened. BT launched a tech fund at the height of the dot-com boom because it was easy to sell. They put "sexy" dot-com stocks in their portfolio because they made the product easier to sell. And they burnt their clients beyond a cinder of recognition.

Pretty it was not.

They did it because they got led by their sales force. If you do what the sales force wants and you have a competent sales force you will sell lots of funds. As a funds management business you will be big and profitable.

But the target for BT Funds Management's sales force was a financial planner in Doncaster (10 miles from Melbourne) with gold-rim spectacles (or the same in Parramatta or any other middle suburban Australian center). These guys are the modern bell-boys. Whey they are putting their clients into tech stocks there is nobody left to sell to.

And so it is - the most extreme example I have ever seen of the conflict between managing money and selling funds management products.

Imagine the patter

I wish I had a recording of a BT "sales call" from say April 2000. The market was off pretty hard - but all was OK in the financial planner in Doncaster. Economic growth looked great. The record for the NASDAQ measured in Australian dollars was astounding - not only because the NASDAQ was astounding but the AUD had collapsed to below 50c in the dollar.

The image projected would have been competence, technical sophistication and certainty.

About this time I ran into David Drury, then CEO of Principal at a CSFB insurance conference in New York. He found out I was Australian and regaled a circled crowd with his version of the BT mid-2000 spin. BT Funds Management was a very fine asset. Later I told two of the people in the circle that I thought the acquisition would cost him his career - but I did not have the courage to tell Mr Drury himself. In my memory I like to kid myself I did have that courage - but whilst I had that view I was racked with doubt about it. Mr Drury was an important man with an illustrious career, BT had a great reputation and I was just a junior analyst.

Mr Drury was a better salesman than I will ever be. He projected the illusion of certainty. [See here and here for a discussion about that illusion...]

Good spin versus good funds management

What makes for good funds management is -

(a) contentious, but well thought through opinions,

and in direct contrast,

(b) doubt sufficient to make sure the downside is always well covered

This is a schizoid requirement. People who have both these features are strange - flat out weird.  People with only (a) are engaging but dangerous.

At Bronte we have both - but only because there are two of us. I am the contentious one. My business partner - his job is to extinguish any passions that I might have. [He is a real spoilsport - ed.]

How to manage financial product salesmen

A good financial product salesman knows things that a fund manager can't know. He knows for instance what is going through the mind of that financial planner with gold-rimmed spectacles in Doncaster. He knows what will sell.

At best he knows how to craft the message so that it will sell, so that it will not trigger any red-flags, so that it will make the recipient comfortable.

And that is good, you can say things in a glass half-empty way or glass half full way without bending the truth. Trivial example: risks are a bad thing, so focusing on the the risks does not sell your product whereas risk management is a good thing so focusing on that might help you sell. You can't actually do good risk management unless you focus on risks - but the angst that gives a good fund manager need not be seen by clients. A good salesman will hide that angst because - well - what sells is the illusion of certainty.

But a salesman who drives changes in the product because, so changed, the product will sell better is on the path that eventually destroyed both BT and Mr Drury's career. And good sales people are empathetic to the needs and desires of their targets so that is the path they tread...

But it is a dangerous path. Really dangerous.

I know (and respect) a fund manager with a very harsh solution to this. When the salesman tells him how to design his product he gives him a warning. The second time he fires him.

He has gone through a few sales people. And eventually he sold lots of product because the performance was too good to ignore.

But it is harsh, unpleasant and not very effective as a sales strategy.

Anyone got a better idea?








John

*Retrospectoscope is - to my knowledge - a Trade Mark of Platinum Asset Management - a very fine firm who took over BT's dominant Australian position.

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