Whitney Tilson On T2 Partners' Netflix Short, Shorting Skills In General

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Last month T2 Partners' fund declined 2.8 percent in January, with declines of 4.3% (net) in the last five months, which managing partners Whitney Tilson and Glenn Tongue noted "in isolation, isn't a terrible number." Having said that, "given that the S&P has surged 23.5% over the last five months, this has been, by far, our worst relative performance in history." So, some thoughts are necessary.

On strengths vs weaknesses: "Over time we’ve been quite successful shorting fads, frauds, promotions, declining businesses, and bad balance sheets. Where we have had much less success, however, especially in recent months, is shorting good businesses that are growing rapidly, even when their valuations appear extreme. Such open-ended situations, regardless of valuation, are very dangerous, so going forward we will avoid them entirely unless we have a high degree of conviction about a specific, near-term catalyst."

On 'deemphasizing' shorting: "A far bigger mistake we made was maintaining a large short book even after the crisis had passed. Allow us to explain why this occurred by starting with some background: From 2003 through 2007, our typical portfolio positioning was 80-100% long and roughly 20% short. In early 2008, when we became convinced that the housing market would collapse, we tripled our short book to around 60%, with an emphasis on highly leveraged housing, real estate, and financial companies that were most exposed to the subprime bubble. Needless to say, this worked out spectacularly well – so well, in fact, that we became accustomed to running a short book in the 50-70% range and – we’re embarrassed to admit – we pushed to the back of our minds two facts that have always been true: 1) shorting is a terrible business (as we highlighted in our book), and 2) we’re much better long investors than short investors. Said another way, long investing is a massively better business than shorting, plus our experience, skill set and temperament is much better suited to it. We will not forget this again.

To be clear, our conclusion isn’t to abandon short selling altogether. Done very carefully and selectively, in limited size, we are confident that our short book can provide both hedging and positive returns. But at most times we will have a short book in the 25-40% range.

In summary, we are redoubling our focus on what we do best – buying cheap stocks – and are deemphasizing short selling – both in terms of time and capital. Still, we are always keeping a close eye out for the occasional big bubble that might give us the opportunity to make a lot of money on the short side."

On Netflix: "Since we first wrote to you in December about our Netflix short position, we have received quite a bit of new information including results from our survey, input from investors, and the company’s recent earnings release. We are still digesting this information, which has both bullish and bearish implications, and will write to you about our conclusions in the near future. "

T2 January Letter To Investors [PDF]

Related: Netflix CEO Applauds Hedge Fund Manager’s Call, Balls To Short Company, Would Still Appreciate If He’d Refrain From Doing So

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FYI, Whitney Tilson's Investment Thesis On Goldman Sachs Has Not Changed In Light Of Times Op-Ed (Update)

Having said that, T2 Partners will be "monitoring" the situation. The op ed in today’s New York Times by retiring Goldman Sachs Executive Director Greg Smith is the talk of Wall Street. We think we know Goldman well, as the company has been our prime broker for the past seven years and Goldman (both stock and call options) is one of our largest positions, so we wanted to add our comments. Our direct experience as a client of Goldman has been universally positive. The many people we have dealt with there have all been exceptionally talented and high-grade, and never once have we had a negative experience in which we felt that they took advantage of us or didn’t do what they said they would do. That said, we are not naïve. In all of our dealings with Wall Street firms, we assume that they are looking out for their own bottom lines, not ours. And we are certainly aware that the old, gentlemanly culture in which integrity and a customer-first attitude generally prevailed is long gone – not just at Goldman, but across all of Wall Street – and, in fact, across the entire financial industry (the reasons for this and what should be done about it are the subject for another day). When we think about investing in any company – especially a financial one, which is heavily regulated, leveraged, and particularly difficult for an outsider to analyze – we factor into our investment equation our assessment of the company’s culture and values, and, if we have any concerns, what the potential associated risks are, such as unexpected losses and regulatory action. In light of our view of the moral decay across the U.S. financial sector, we aggressively haircut our estimates of intrinsic value in the sector – some companies more so than others. But at some price, of course, any stock is a buy, and last August and September we felt that the negativity surrounding the financial sector was way overdone and hence made a big – and, so far, very profitable – bet on Goldman and a number of other U.S. financial firms. With the run-up in Goldman’s stock – after falling below $90 as recently as December, it’s now over $120, just above tangible book value of $119.72 as of 12/31/11 – we’ve been debating whether to trim or exit our position, so today’s op ed is timely. But is it relevant to our investment thesis? We think probably not, for two reasons: 1) The argument that Goldman has become increasingly profit driven, sometimes at the expense of clients’ best interests, and that some employees use vulgar and disrespectful language is hardly news. What’s the next “shocking” headline: “Prostitution in Vegas!”? 2) We highly doubt that Goldman is as truly corrupt as Smith makes it out to be. Goldman has more than 30,000 employees (including nearly 12,000 vice presidents, of which Mr. Smith is one) and has gone through wrenching changes in the past year, including savage cuts to bonuses and extensive layoffs, so it doesn’t surprise us that there are many disgruntled employees, especially those who are leaving. Is Smith one of them? It’s hard to tell, but here’s an email sent to me this morning by a former partner at Goldman (who generally agrees that the firm’s culture is not what it once was): There are a couple of things out of place. 1) This guy has been at firm for 12 years and is only a VP…a piss ant of sorts. He should have been an MD-light by now, so clearly he has been running in place for some time. 2) He was in U.S. equity derivatives in London…sort of like equities in Dallas…more confirmation he is a lightweight. Somewhere along the line he has had sand kicked in his face…and is not as good as he thinks he is. That happens to a lot of high achievers there. In summary, we think it’s likely that Goldman does the right thing for its clients the vast majority of the time – but not as certainly as it used to in the old days. Times have changed and the trend is unfortunate, but it is not unique to Goldman. In fact, we believe that Goldman still has a better culture and is more ethical than most of its competitors – though this is a very low bar to be sure. Our investment thesis on Goldman is simple: when all the dust settles, it will remain the premier investment banking franchise in the world – and, if so, will be worth a substantial premium to tangible book value. Smith’s column is a warning flag that we’ll be monitoring closely, but we believe our investment thesis remains intact and the stock is still cheap, so we’re not selling.

Whitney Tilson Was As Surprised As You Are To Learn That He Was Long Netflix On The Way Up

NFLX is up 75% year to date so you probably assumed that Whitney Tilson had gotten rid of it sometime last year. You were not alone: We thought it was a little strange when Whitney Tilson and Glenn Tongue's hedge fund T2 Partners' latest 13F came out earlier this week and Netflix wasn't included. We sent the hedge fund manager an email to find out why and there's now a corrected version of the fund's regulatory filing out. It turned out, it was just an error. As of December 31, 2011, T2 Partners had combination of 89,771 shares and 81,000 call options in Netflix, according to the updated 13F. Here's Why Whitney Tilson's 13-F Didn't Have Netflix In It When It Came Out [BI]