Four Views On Gold And Gold Miners

1.) Atyant Capital, “What is gold saying?”:

Gold stocks lead gold and gold leads currencies and currency moves correlate with stocks and bonds. Gold stocks have been declining for two or so years now. This is in part due to unavailability of capital and credit for gold mining projects, but in our assessment, not the whole story. We believe gold stocks are also correctly forecasting lower gold prices.

Long term readers know my gold pricing model puts fair value at $1100 per ounce (Alpha Magazine Aug 24, 2011). So at $1700-$1800, gold was about 60% overvalued, floating on a sea of credit. Gold declining now tells me the sea of credit is receding here and now. This should translate to a higher US Dollar and pressure on asset prices globally.

2.) Value Restoration Project, “Gold miners – Back in the Abyss – An Update“:

Gold mining stocks remain cheap by almost any objective measure.

One way to look at mining stocks is to compare them to the price of gold itself.

Comparing miners to the price of gold itself, show miners are cheaper today than they have been in decades.

[…]

Today, gold appears undervalued relative to the growth in the monetary base that has occurred up to now, and in light of the monetary expansion the Fed and other central banks are currently undertaking, gold appears more undervalued. The Fed’s current quantitative easing program probably won’t be curtailed until households stop deleveraging and the government can handle the rising interest expense on its expanding debt.

Yet, in the face of all this, many gold mining stocks are now selling at valuations that suggest the market has priced in a decline in the price of gold back to 2007 levels, before the Fed began expanding its balance sheet during the financial crisis. Many gold mining stocks are now selling near or below their book value, which is the market’s way of saying that these businesses won’t be able to add shareholder value in the coming years by mining gold and silver. If the price of gold were to decline below $700 or so, it would certainly be the case that most mining companies wouldn’t be able to profitably sell gold. Yet such a decline in gold is the main implied assumption being priced in by the market today, and this has sent valuations of gold mining stocks to their lowest levels since the current bull market began.

3.) Robert Blumen, “What is the key for the price formation of gold?“:

The gold price is set by investor preferences, which cannot be measured directly. But I think that we understand the main factors in the world that influence investor preferences in relation to gold. These factors are the growth rate of money supply, the volume and quality of debt, political uncertainty, confiscation risk, and the attractiveness (or lack thereof) of other possible assets. As individuals filter these events through their own thoughts they form their preferences. But that’s not something that’s measurable.

I suspect that the reason for the emphasis on quantities is that they that can be measured. Measurement is the basis of all science. And if we want our analysis to be rigorous and objective, so the thinking goes, we had better start with numbers and do a very fine job at measuring those numbers accurately. If you are an analyst you have to write a report for your clients, after all they have paid for it, so they have to come up with things that can be measured and the quantity is the only thing that can be measured so they write about quantities.

And in the end this is the problem for gold price analysts, you’re talking about a market in which it’s difficult to really quantify what’s going on. I think that looking at some broad statistical relationships over a period of history, like gold price to money supply, to debt, things like that, might give some idea about where the price is going. Or maybe not, maybe you run into the problem I mentioned about synchronous correlations that are not predictive.

Part of the problem is that statistics work better the more data you have. But we really don’t have a lot of data about how the gold price behaves in relation to other things. The unbacked global floating exchange rate system has never been tried before our time. How many complete bull and bear cycles has the gold/fiat market gone through? My guess is that when we look back we will see that we are now still within the first cycle. Our sample size is one.

[…]

I do think we will have a bubble in gold, although it may take the form of a collapse of the monetary and a return to some form of gold as money in which case, the bubble will not end, it would simply transition over to the new system in which gold would go from being a non-money asset to money.

I have been following this market since the late 90s. I remember reading that gold was in a bubble at every price above 320 dollars. I very much like the writings of William Fleckenstein, an American investment writer. He has pointed out how often you read in the financial media that gold is already in a bubble, a point he quite rightly disputes. Fleckenstein has pointed out that the people who say this did not identify the equity bubble, did not believe that we had a housing bubble, nor have they identified the current genuine bubble, which in the bond market. But now these same people are so good at spotting bubbles that they can tell you that gold is in one.

Most of them did not identify gold as something which was worth buying at the bottom, have never owned a single ounce of gold, have missed the entire move up over the last dozen years, and now that they’re completely out of the market, they smugly tell us for our own good that gold is in a bubble and we should sell.

So, I don’t know that we need to listen to those people and take them very seriously.

4.) Me:

I don’t know what the intrinsic value of gold is. I don’t think gold mines are good businesses (on the whole) because they combine rapidly depleting assets with high capital intensitivity and they are constantly acquiring other businesses (mines) sold by liars and dreamers and schemers. And I don’t think this will end well, whatever the case may be. So, I am happy to own a little gold and wait and see what happens.

I wonder what the short interest is on gold miners?

Advertisements

Interview With David Baran Of Tokyo-Based LBO Fund Symphony

This is worth watching if you’re a value-investor interested in the Japanese equity market.

Description of the video from YouTube:

David Baran, Co-Founder of Symphony Financial Partners, has over 20 years of experience investing in Asia. He has lived in Asia and Japan for nearly 3 decades and is fluent in Japanese.

Baran’s SFP Value Realization Fund was launched in September 2003 when Nikkei was about 9,500. The index has fallen since then, yet his fund is still up 56% after fees.

The secret to achieving returns in Japan is that you’ll have to do more than just long-only investing. The unloved, under-covered nature of the Japanese market creates opportunities that ordinary fund managers are not capable of pursuing because it’s too hard to extract the value. Many Japanese firms, particularly the smaller ones, can boast about 40+% operating profits and 30+% EBITDA margins. They can have net cash positions and trade at 50+% net cash to market cap. Hundreds actually trade at over 100% net cash to market — which means the market is valuing these viable businesses at zero.

“Investors in the U.S. equity markets would be falling over themselves to invest in a company like these – net cash, strong business moat and growth prospects,” says Baran. But being “cheap” isn’t enough — you need catalysts to unlock the value.

M&A activity flourishing in Japan

Corporate activity is such a catalyst. MBOs have an average premium of 50% (!) and sometimes reach triple digit numbers. Many of the large Japanese conglomerates started to buy back listed subsidiaries. Baran also advises on the Sinfonietta Asia Macro hedge fund, one of the best performing Asian hedge funds in 2001.

Hear David speak about:

* The 8 reasons why management buyouts are gaining popularity

* Why you need catalysts to unlock value in Japan equities

* What investors are missing by considering Japan as an “asset class”

* How to avoid “value traps”

* Considering tail risk: Why Baran’s Sinfonietta hedge fund is “geared towards a disorderly market”

Can Best Buy Be Fixed? Reply To @vitaliyk

A value investor by the name of Vitaliy Katsenelson, whose blog I subscribe to, just posted his ideas on How to Fix Best Buy:

Best Buy cannot have lower prices than its online competitors, and its stores lack the breadth of selection of Amazon.com, putting it at a permanent competitive cost disadvantage.

The new strategy Dunn announced a few weeks before his resignation — of closing big stores and opening a lot of smaller stores — made little sense. It was basically turning Best Buy into RadioShack Corp. It would have been great if this approach had worked for RadioShack, but it hadn’t.

Katsenelson is correct. Best Buy’s business model is cooked. It provides a service that is increasingly out of touch with how consumers of its products shop, and it does it within a cost structure that is not price competitive with the other participants in its market.

So, Katsenelson proposes a solution for Best Buy:

Best Buy’s strategy for the brave new world requires thinking that cannot be delivered by somebody who spent 28 years in the Best Buy box. It requires the strategy of an Amazon or Netflix, where management was willing to bring forward and execute a disruptive new approach that undermined its current cash-cow business. Amazon did this by bringing electronic readers to the masses. Netflix did it by streaming movies and TV shows.

The rest of Katsenelson’s proposal, while creative and worth pondering on its own from a strategic value point of view, is unimportant for the purposes of our present discussion, which is actually to highlight the role of innovation.

According to our reading of The Innovator’s Dilemma, Katsenelson is suffering from two confusions in his analysis:

  1. He is confused about the difference between sustaining and disruptive technologies
  2. He is confused about the likelihood of success in a firm disrupting its own business model

Let’s tackle each confusion separately before reaching a new conclusion.

Confusion #1 – sustaining vs. disruptive technology

In building his analysis of Best Buy’s current predicament, Katsenelson cites the examples of Amazon’s Kindle and Netflix’s digital streaming technologies as examples of “disruptive” technology.

It might be useful at this point to revisit the definition of sustaining versus disruptive technology provided to us by The Innovator’s Dilemma before proceeding:

  • sustaining, which are new technologies that improve a product or service in a way that is valuable to existing customers or markets
  • disruptive, which are new technologies that are uncompetitive along traditional performance metrics, which are unusable or undesirable to existing customers or markets but which nonetheless can eventually come to replace the traditional market over time

(A disclosure here, as well– I have not studied Amazon nor Netflix in depth, so I am making some conjectures here about margins and pricing which may be incorrect, and I realize they are central to the point I am making so it could weaken my argument slightly if I am speaking out of turn here.)

Now, judging by the definitions above, I’d say both Amazon’s Kindle and Netflix’s digital streaming service are actually sustaining technologies, not disruptive. A good clue to the truth of this might come in the fact that these technologies each were developed and implemented from within the firms in question, rather than being produced by an entrant, competitor firm.

But even if that is not the give away, sure both of these technologies improved their existing products and services (books and movie rentals, respectively) and both were appealing to existing customers. It is not my understanding that there were a bunch of people who were not buying books and not renting movies until Amazon and Netflix released their new services, at which point they jumped on board. In fact, it is my understanding that many customers who now use the Kindle or digital streaming were previously physical book readers or mail-order movie renters.

Additionally, my understanding is that these new businesses are either similar margin or better margin businesses than what came before. I understand Netflix has had issues with the cost of acquiring distribution rights to film properties but that seems a separate issue from the actual question of the cost of distribution– digital streaming seems far more cost effective than sending things through the mail. Same with e-readership; the question of acquiring separate rights for digital distribution is a different one than the cost of distribution, of which digital book distribution seems to be a far higher margin business than the one involving costs of inventorying and mailing physical copies of books.

This is another aspect of the sustaining vs. disruptive technology debate– firms on sustaining technological pathways look for higher margin business that satisfies their existing customers and provides them with improved, but similar service to what they had before. Disruptive technological pathways involve different (usually lower) cost structures and different products or services which are competitive on metrics or feature sets that were previously not an issue in the pre-existing competitive paradigm.

Best Buy was, in its heyday, an electronics and appliance retailer where customers not only shopped but transacted. Nobody wants to transact with Best Buy anymore. That truly is a disruption as now people just want to shop. Any proposal that involves Best Buy no longer being a retailer (shopping AND buying) is a proposal for disruptive innovation within Best Buy’s existing business model, and a change in cost structure that would go along with it.

Confusion #2 – the likelihood of success in self-disruption

The other thing that’s clear from reading The Innovator’s Dilemma is that responding to a disruptive threat from an entrant firm is hard enough, but successfully disrupting one’s own business model is nearly impossible.

There are myriad reasons why this is so but what it essentially boils down to is that, as Geoff Gannon says, businesses have DNA and part of their DNA is their cost structure. Asking a business to change its cost structure is like asking it to change its DNA; it’s akin to expecting a megalodon to transform itself into a tick.

Another part of a business’s DNA is its management culture and accumulated experience. Just as certain animal species seem to have integrated various memory experiences into their DNA which are expressed as subconscious, instinctive behavior that comes naturally and effortlessly to the animal, a business develops a management culture (tightly interwoven with and often times predicated on the business’s cost and incentive structures) that possesses a kind of collective memory, or instinct. Management culture is “evolutionary”– it’s highly specialized and adaptive, designed to excel in the conditions unique to that business’s industry but which may prove maladaptive in conditions dominating outside of the industry.

Expecting a company’s management to successfully adapt its culture, its DNA, to new competitive circumstances is like expecting a polar bear to hunt successfully after air dropping it into the African savannah, or a jungle on the Indian subcontinent.

Getting rid of the top executive is not enough. CEO Brian Dunn might be gone, but all his lieutenants remain. They’re like mini-Brian Dunns, the children of Brian Dunn, they might not be exact replicas but they’ve undoubtedly learned a lot and probably “grown up” believing in his authority and vision the way children have trouble question their parents. They bring all that along with them. (David Merkel discussed this phenomenon in his bond manager series where he talked about the way a corporate debt team will come to be subtlety but surely influenced by the PM, and it applies in other business organizations outside the world of corporate bond management.)

Everyone who works at Best Buy is used to succeeding (and failing) a particular way. It is unlikely they’ll find themselves succeeding in a new paradigm that’s completely foreign to them when they are failing to sustain their business in a paradigm they’re intimately familiar with and once dominated.

A third way? Dissolution, sub-disruption, liquidation?

Katsenelson’s two examples don’t shed much light on what Best Buy should do because they’re examples of successful adoption of sustaining, not disruptive technologies. Best Buy is facing disruptive competition, it is beyond the point where its business could be improved by a sustaining technology.

And self-disruption doesn’t appear to be a viable strategy because Best Buy has built-in business DNA which can not be easily mutated, if it can be changed at all.

So, what should Best Buy do?

One perfectly reasonable strategy could be dissolution (aka liquidation by change in ownership)– Best Buy could sell itself to a strategic buyer who values Best Buy more as a sum-of-parts than as its currently operating whole. The new owner could salvage and re-orient what it can and then re-sell the rest as “scrap”. Just because the Pinto explodes when it gets rear-ended doesn’t mean the metal and upholstery in the vehicle couldn’t be used elsewhere. This is an option.

Another strategy is for the company to liquidate itself– managed, slow-motion suicide. The company could cut cap-ex to zero, start winding down its inventory buying and other business activities in line with the maturation of its existing facilities leases and then close out the stores one by one (selling property, plant and equipment when possible as this process continues). The proceeds could be distributed as periodic dividends to shareholders or be distributed as a lump-sum cash payment in exchange for shares at the end of the process several years from now.

But there is a third way and it actually does involve self-disruption: Best Buy could set in motion the slow-motion suicide or not, and at the same time use some of its capital to set up a small subsidiary to either compete in the world of Amazon, or work at discovering another disruptive technology which could re-jigger the industry even more and prove a disruptive threat to Amazon. This subsidiary would have completely separate managementcompletely separate capital and a completely separate cost structure which would be appropriate to the new market it is attempting to compete in.

That’s one way Best Buy could successfully respond to innovation in its industry. But it’s most likely far too late for that.

Which is why I think it’s pretty clear Best Buy is a value trap outside a strategic buyer coming into the picture (Schulze might be a little slow to the draw, but at least he’s got the good sense to go for his revolver before his opponent six-shoots him into a shallow grave), or the current management dedicating itself to a program of self-liquidation over the next several years.

DreamWorks Animation Trading At Unreasonable Multiples Of Current And Future Value

A bet on DWA is, in a macro sense, a bet on the current paradigm of the value of Hollywood studios as creators and distributors of valuable entertainment IP. The fate and value of DWA, even though it’s its own company with its own strategy, its own management and its own niche within the industry, is inalienably tied up with that model of sourcing IP, producing a theatrical event centered around the IP and then profiting off of the multi-channel distribution and licensing bonanza related to that IP across time (multiple years/decades after the initial theatrical event) and space (around the globe).

How does DWA make money?

Like most film studios, DWA is essentially a vehicle for financing and marketing computer-animated family film IP. The process begins with an idea, the eventual IP in natal form, which is either pitched to the studio by an outsider and then purchased, or developed internally by the studio’s internal staff. Over the next 3-4 years, at a cost of $125-175M per IP property, the idea is nurtured, developed and finally produced into a feature length film “event”. Working with the studio’s distribution partner, the film is released first in the US and then worldwide to theater audiences. Several months after theatrical release, the film property is put into home entertainment– DVD/Blu-ray, domestic and foreign Pay-per-View/VOD, domestic and foreign free TV and eventual distribution to in-flight entertainment and US military theaters. Toys, corporate licensing partnerships, clothing and other spin-off opportunities may follow, and if the IP is especially successful at the box office it may spawn sequels, live stage performances, TV spin-off franchises and TV holiday specials– a franchise title is born! Eventually, the cost of development of all IP in release is fully amortized or written off against revenues and the title is transferred to the “film library”, at which point it no longer exists on DWA’s balance sheet even though it will likely continue to generate licensing revenues for years to come.

The major threats to this model right now are:

  • the secular decline of the high-margin DVD distribution model and the uncertainty of the rise of digital distribution, which is not only (currently) a lower margin business, but whose time-footprint threatens the value of the traditional time-delay release of a film events IP across traditional distribution channels (free TV, pay TV, DVD/home video, etc.) because of the opportunity for worldwide simultaneous release
  • the hard costs of digital animation are falling, inviting more non-studio (independents) and amateur creators to enter the space

Some mitigating factors are:

  • assuming that internet/digital distribution proves to be a sustaining rather than disruptive technology, even if the cost of creating computer-animated film properties is falling, it still costs hundreds of millions of dollars to distribute that IP to a global audience and create the kind of “film event” that allows for a blockbuster franchise to be born
  • computer-animated family film IP has proven more resilient than live-action film IP within the declining DVD biz, because parents view their purchase decisions toward CG-film IP like that of a long-life toy that will be used to entertain their children again and again, preserving the value proposition of such a purchase
  • though this author is skeptical of the bullish case for emerging markets generally, and though emerging market territories generally have stingier revenue-sharing agreements with foreign (read: DWA) studios, and while the foreign home entertainment markets are currently weak to non-existent, these markets are in a secular growth pattern, their home entertainment markets are developing and they will mean larger and larger worldwide audiences for each film event as time passes; the risk of failure becomes less and less and the profitability of a homerun becomes greater and greater
  • DWA is intelligently pursuing growth in the emerging market nations– it has developed animation partnerships and facilities in Bangalore, India; it has recently announced a JV with state-owned media enterprises in China where it will not only develop original IP exclusively for the Chinese/Asian market, but it will likely also have the opportunity to distribute its US IP through that channel and thus earn future film rentals as a “local” rather than “foreign” producer, increasing its share of box office and other revenue-streams
  • DWA/Katzenberg have fully embraced theatrical 3D, which allows for premium pricing (typically, +$5 to cost of theater admission) which exit surveys of theater-goers rate as a huge value add. 3D is extremely popular in overseas markets, as well, and already over 50% of new release film rentals have been generated by 3D ticket sales on a per-film basis. 3D requires a small up-front additional investment to add the effect to films yet can be leveraged into a huge additional premium on ticket sales.

If you think those threats are overrated, then DWA is probably extremely cheap. If you think those threats haven’t been fully priced in, DWA is either fairly valued or expensive, the ominous “value trap” every value investor fears walking into.

I am more and more of the opinion that DWA is a classic, Buffett-style good company at a great price-type business. Management is competent and trustworthy, and because Katzenberg and other officers and insiders of the company hold substantial equity stakes, their incentives are aligned (most of Katzenberg’s outstanding stock options, by the way, have strike prices in the $30/share range). While the development of the company’s IP is capital intensive (again, costing $125-175M per film to produce), the IP generates a multiple of that expense in ultimate profits on average. This means the company retains a substantial proportion of its earnings and is able to fund future production internally. The company is conservatively financed with no debt and sufficient cash and receivables (which is cash awaiting release from their distribution partner) to fund the development of two or more films at any given time. The business consistently earns a high post-tax ROE and pre-tax ROIC. While every studio has tried to get in on the computer-animated family film space, Pixar and DreamWorks are largely dominant (with near third place going to Fox’s Blue Sky) and the brand awareness and market share of each studio has not changed significantly over the last decade, implying high barriers to entry and strong competitive advantages to the entrenched firms like DWA.

Looking at earnings on a 10yr, 8yr (since 2004 IPO) and 5yr (since the secular DVD decline began in 2006, and including the traumatic period of 2008-2009) average, earnings are growing.

On a GAAP basis, the company trades close to book value, but this is a book value which holds the fully-amortized prior release films in the “film library” at a $0 value on the balance sheet. They’re obviously worth a great deal more, especially to a strategic buyer. On an adjusted basis, DWA is trading at a significant discount to book value.

The market cap of the company is about $1.44B at a share price of $17 with 85M fully diluted shares outstanding. The beauty of DWA is that it is not so small that it can get blown over in the wind with a poorly-received film event release, but it is not so large that it is already a fully-integrated media conglomerate in its own right, with theme parks and all the rest. In other words, it’s got a long run way and the market capitalization could grow significantly overtime, so it isn’t hard to imagine where DWA will find additional revenues and earnings streams over the next 10 years like a person might wonder with a competitor such as DIS. It’s trading near all-time lows and right now it trades for less than it did at the fear-induced trough in the markets in late 2008, early 2009.

Management has aggressively bought back shares since the 2004 IPO and secondary offering, reducing shares outstanding by over 20% during the last 8 years. The board has authorized an additional share repurchase plan which represents about 10% of market cap at current prices.

There are some challenges and uncertainties for DWA. There always are, for every business. If this is a value trap, then we are on the verge of the complete dismantling and dissolution of the Hollywood studio system of film production and distribution. If we are not on the eve of that armageddon, then DWA is not being fairly priced. And there is a significant margin of safety in the numerous growth opportunities available to this “wide-niche”, focused and ambitious firm with strong brand reputation. With the studio committed to producing 2.5 films/yr from the previous strategy of 2 films/yr (one sequel and one original), earnings will be growing and yet you pay the already discounted 2 films/yr price.

It’s hard to imagine this company worth less than $1.44B 10 years from now and it seems likely it will be worth significantly more over that period of time, with an additional 25 films in the stable (a greater than doubling of the current film library of 23 films).

Any way you slice it, DWA seems cheap– <10x GAAP EBIT, <15x GAP Net, 2x GAAP Rev, <10x adj OE (net income + amortization – film costs – avg MCAPX), <8x adj Net OE (OE minus cash taxes paid) and around 5x the 2.5 films/yr pre-tax OE calculation… not to mention a significant discount to adjusted book value.

Pure valuation metrics:

Metric 10yr Avg 8yr Avg 5yr Avg
GAAP EBIT/share  $1.71  $2.18  $2.20
mult 10.0 7.8 7.8
GAAP Net/share  $1.19  $1.80  $1.81
mult 14.4 9.5 9.4
GAAP Rev/share  $7.42  $8.19  $8.55
mult 2.3 2.1 2.0
Adj OE/share  $2.04  $2.38  $2.51
mult 8.4 7.2 6.8
Adj Net OE/share  $1.94  $2.47  $3.00
mult 8.8 6.9 5.7
Adj 2.5 films/yr Pre-tax OE  $2.18  $3.06  $3.28
mult 7.8 5.6 5.2
Share price  $17.08  $17.08  $17.08

Notes on insider ownership:

According to the latest 14A, Jeffrey Katzenberg, the CEO of the company, owns 13,193,947 shares, or 15.6% of total fully diluted shares outstanding. He also controls a number of options awarded to him as executive compensation (he draws a $1/yr salary), most of which vest only if the share price maintains around $30+/share for approximately one year within the multi-year window of the stock option compensation agreement. So, Katzenberg is highly incentivized through both equity ownership and stock options to see a valuation for the company significantly higher than it currently stands.

Additionally, current executives as a whole (including Katzenberg) control 19.1% of FDSO.

Former founders David Geffen and Steven Spielberg, who are no longer actively involved in managing the company, continue to hold 2,355,216 shares or 2.8% and 5,222,726 shares or 6.2%, respectively, of FDSO. (Note: David Geffen and Jeffrey Katzenberg jointly own approx 10M shares of Class B voting stock, which I did not account for in Geffen’s total holdings but did include in Katzenberg’s holdings because of Katzenberg’s current role in active management of the company. The Class B stock controls 67.4% of the total voting power of all shareholders.)

Catalyst:

There is no short-term, identifiable catalyst to unlock the value here. This is a long-term, buy-and-hold value compounder. You are making a bet on the market severely mispricing the value of this company in the present while assuming the market will be able to better ascertain the value (which continues to grow within a strong franchise) in the future. The company has a number of values to different owners (including potential acquirers or even management itself) and any one of those events, or none of them, could ultimately result in the true value of this firm being realized.

This is not a trade, it’s an investment. Wall St hates things like this.

Flight Of The Permabulls?

Legg Mason’s Bill Miller, famous for being permabullish during the entirety of the world’s largest bubble of all time (essentially his whole career, when he kept catching his one card straight draw on the river with bailout after Fed-engineered bailout over and over again), is finally calling it quits (Bloomberg):

Bill Miller, the Legg Mason Inc. (LM) manager famous for beating the Standard & Poor’s 500 Index for a record 15 years through 2005, will step down from his main fund after trailing the index for four of the past five years.

Miller, 61, will be succeeded by Sam Peters as manager of Legg Mason Capital Management Value Trust (LMVTX) on April 30, which is the 30-year anniversary of the fund, the Baltimore-based firm said today in an e-mailed statement. Miller will remain chairman of the Legg Mason Capital Management unit while Peters will be chief investment officer.

Miller, a value investor known for his bullish views of the economy and stock markets, became mired in the worst slump of his career as he wagered heavily on financial stocks during the 2008 credit crisis. Value Trust lost 55 percent that year as the S&P 500 dropped 37 percent, including dividends, prompting a wave of withdrawals. The fund’s assets have plunged from a peak of $21 billion in 2007 to $2.8 billion.

Bill Miller is a living example of selection bias at work. Notice what happens when his coin-flipping strategy of “heads” stops working.

We’ll likely see more announcements like this from other “top stock pickers” of the past few decades in the coming months and years. Good riddance!

Whitney Tilson’s Terrible, Horrible, No Good, Very Bad Investment

Whitney Tilson, famed value investor and manager of T2 Partners, has had a tumultuous and sordid affair with NFLX, a company he first failed to romance as a spectacular ever-rising short and which he now may very well fail to romance as a spectacular ever-cheapening long (Bloomberg):

Tilson had bet against Netflix from at least December, when he first wrote about shorting the stock, until February, when he disclosed to investors in a letter that he covered the short and was no longer confident that his investment thesis was correct. Tilson said he decided to buy shares today because he deemed them “cheap.”

“It’s been frustrating to see our original investment thesis validated, yet not profit from it,” Tilson, 44, said in a statement e-mailed from his New York hedge fund. “The core of our short thesis was always Netflix’s high valuation. In light of the stock’s collapse, we now think it’s cheap and today established a small long position. We hope it gets cheaper so we can add to it.”

Netflix plunged 35 percent to close at $77.37 in New York trading, its biggest drop since Oct. 15, 2004. The shares have declined 56 percent this year.

This is every investor’s worst nightmare and I am not calling attention to this to slander or heap ridicule on Tilson. Far from it– I don’t know if I’d have the cajones to go long a stock (at nearly 18x earnings) that I was previously trying earnestly to short.

That being said, let’s review this performance. If he started shorting in December he probably did it around $165-170/share. If he covered in February it was probably anywhere from $205-220/share. Let’s say $165/share short and $210/share cover. That’s a 27% loss.

The good news is the stock went as high as approximately $298/share, so he dodged that bullet. But then it plunged dramatically since then and is now trading at about $77/share. Assuming Tilson had just held his short (and kept making margins calls, or better yet, kept adding to it), he would’ve ultimately made a 53% gain!

What’s interesting about this? One, it would’ve taken Tilson nearly a year to be vindicated in his thesis. Value investors typically think of themselves as “long-haul” capital allocators. But in the world of shorting, time scales are compressed and a period like a year is more like a decade. A lot more seems to change. The moral of the story, perhaps, is to focus on shorts where you have identified an immediate, short-term catalyst that will cause the market to abandon its effort to push the stock higher. Simply recognizing a stock is overvalued doesn’t appear to be robust enough.

Two, investor psychology appears to be completely different between shorts and longs and with good reason. With a long, many value investors (like Tilson) invite the position to go against them, at least temporarily, rationalizing that this just makes it cheaper and easier for them to make money when their investment plays out. But with a short, where your potential loss is infinite, no investor ever has nor I assume ever will invite the position to go against them. Nobody ever says, “I hope the stock rises substantially from here because it just means another opportunity to short it more and make more money when it finally crashes.” Instead, many end up throwing in the towel, often at the worst possible moment.

Three, this episode demonstrates the need for humility. It’s possible Tilson will eventually make a good bet with his decision to go long NFLX. But if he doesn’t, he’s going to look doubly foolish, rather than singly. And, because he’s had a poor experience with this company once before, he risks making rash, emotional decisions about it in the future out of a subconscious effort to conquer his fear or slay the wild beast that marred him in battle once before.

If I was a big T2 investor, I’d be wanting to know what kind of safeguards Tilson and his team have put into place to prevent emotional bias from getting in the way of their analysis of NFLX going forward. And frankly, I’d have a hard time fighting my urge to tell Tilson to just leave the damn thing alone and reminding myself that I invest with him because I trust his judgment and if I were the expert I wouldn’t be paying him to manage part of my wealth.

The good news is Tilson is an experienced, grizzled value investor with an outstanding track record so even if he ends up totally boffing this one again it’ll likely be far from his undoing. For every potentially poor decision like this Tilson has demonstrated he can make many more superior ones and he doesn’t make the kind of levered, concentrated bets that could lead to a one-position wipeout that some of the less savvy figures like John Paulson have suffered in recent months.

Say what you will about value investors but one thing is for sure, they’re generally more prudent than the average bear, and I mean that metaphorically, not descriptively. Then again, this whole episode makes me wonder how Tilson defined his risk, then and now.