Pre-Congress Seminar — Longs and Shorts

by Travis Johnson, Stock Gumshoe | September 30, 2012 7:16 pm

Thoughts on Tesla, Green Mountain, Delia's and more from the Value Investing Congress "pre conference" talks

The Value Investing Congress is always fun, and I’ll be trying to learn plenty that I can share with you in the weeks ahead (and, hopefully, become a better investor myself in the process), but this year I decided to spend a bit more time in New York and take in the pre-Congress seminar as well.

This is where Glenn Tongue and Whitney Tilson, who together have run T2 Funds but now manage their portfolios separately, talk up some of the ideas they have invested in (or not) and their rationale, with the goal of inspiring some discussion about valuation and analysis. They presented their thoughts on more than a dozen companies, including both short ideas (stocks they think will go down) and long ideas, and — though I have two phone book-sized piles of notes and handouts to go through — there were a few that stood out for me.

The first is the small teen retailer Delia’s — or as they prefer, dELiA*s, ticker DLIA — this is a stock that has caught my attention in the past as a value idea because it has often traded at or near their cash balance, which usually gives me at least some reassurance that the stock can’t go to zero. Or at least, that it can’t go to zero very quickly.

For a while, it looked like Delia’s was trying pretty hard to get to that zero stock price — the shares got down to a dollar last Winter, before “bouncing” back to where they are now near $1.40. What’s to like? Well, you could have easily argued that they were circling the drain six or eight months ago, but they had a stupendous quarter last time out that is giving some folks religion. I still would prefer to see them do well for more than one quarter, but at this price I’m starting to think it’s worth a speculation now.

The short version of the story is that new management came in, brought in some expert sourcers and a new fashion person, and they’re essentially going to mimic Forever 21 for a younger set — with very fast changes to inventory, a new set on the floor of the store each month, and focus on quickly following trends instead of trying to set them. That’s all well and good, but what has Tongue and Tilson especially interested — and they’ve owned this one for a couple years, waiting for this turn — is that they have new people on board who turned around competitor Wet Seal very effectively, they have skin in the game (i.e., their money is at stake), and they have put together at least one solid release with excellent same store sales growth that indicates that they are at least starting to “get it right.” Sometimes, for a tiny company that has been a turnaround for a while, just starting to get it fixed is a good point for entry, as the evidence of one good quarter starts to flow through.

It’s also a lesson in “value traps” — stocks that look incredibly cheap but keep getting cheaper, since it was initially bought by these folks at near cash value but still managed to fall by about 50% in the ensuing years … according to their assessment of the value of their assets, they got the business “for free” as investors, but still lost money. So that’s a good reminder — cash on the books doesn’t mean that’s a real “floor” for the price, because a failing company will spend every last dollar trying to turn around … and it will never, ever return that cash to shareholders.

But this one is at least starting to turn around with their “fast fashion” strategy, they described it as “deeply, deeply undervalued.” Though there are a lot of moving parts in their argument, the basic one is this: If they are indeed starting to get it right, then they should trade at something like 1X sales, like other decent mall fashion retailers. Right now they trade at 0.19X sales, so there’s a huge amount of growth potential just from becoming average.

So that’s the story that jumped out at me from our first day of looking at a dozen or so case studies in value investing — there were also plenty of pedestrian notes, like the notion that HP is awful and Dell slightly better, and they both look foolish compared to Apple (with the zinger thrown in that HP spends considerably more on R&D than does Apple).

We also heard a pretty good analysis of Barnes & Noble (BKS), a company that would probably look better as “sum of the parts” story — the book superstores are still generating a lot of cash and doing OK if you don’t expect growth, but they’re plowing all the cash from the stores into building the Nook business, which is losing money but growing really fast … so that means almost the entire company is bet on the Nook, but it doesn’t necessarily have to be, there’s a fair amount of speculation that the Nook business, or the Nook business combined with the college bookstores, might get spun out.

My only trepidation with this is that the valuation of the Nook business relies pretty heavily on big companies making stupid investments, in my mind — the junior investment that Microsoft made in the Nook would, if their valuation was rational, make the Nook business valuable enough that you’d then be getting the book superstores “for free.” That may be a reasonable way of tearing down the company’s assets, but it also presupposes that Microsoft isn’t doing something stupid … and after the billions they’ve sunk into failed web businesses and unpopular mobile devices (Zune and Nokia’s Lumia as a Windows Mobile showpiece being the most recent), I’m not so sure that they’re making rational investment decisions. I still think that at $12-13 I’ll probably find some value if I dig in deeper into BKS, but it won’t be because I’m sure Microsoft was rational in valuing the Nook business at $1.4 billion when they bought their 17% piece of that pie (the enterprise value of BKS right now, equity plus debt, is about $1.2 billion). I haven’t double checked those numbers, that’s from my notes, so be careful if you’re tallying that up.

Some of the most interesting ideas were on the short side, actually — with Tilson essentially guaranteeing that Tesla (TSLA) is going to hit major snags over the next 6-12 months as they start to ramp up production, and that there’s no way they can hit their targets. I definitely agree on that point, though the “story” has been so strong with Tesla that they digested the last bit of bad news pretty well. At some point, the next shoe will very likely drop — I hope Tesla becomes a great company, but the odds of them having a good year in the stock market look very slim.

Other short ideas? Tilson is pretty adamant in calling Green Mountain Coffee Roasters (GMCR), which was crushed by David Einhorn last year, a fraud (“allegedly!” yelled out his partners) in addition to a terrible business — and after looking at their books I can’t see how they keep existing without actually generating any cash flow, a picture that should deteriorate markedly now that generic K-cups are available and the pricing should fall considerably for the only part of their business that had any hope of being profitable. I have never bet against GMCR, but I sure wouldn’t buy it.

And Tilson again reiterated his short position in InterOil (IOC), which is close to running out of money again and is up against some potential catalysts as they’re going to have to either raise more money or bring in a partner. Their gas finds in Papua New Guinea still, according to Tilson, have never been tested to back up the initial gas flares (i.e., they flare gas when they make the discovery, but no one knows if they will flow easily enough to make it worth building a $10 billion plant and infrastructure to export the gas). He’s been betting against this one for a few years, since before I mentioned it for a Matt Badiali tease almost three years ago[1], and it’s hard not to listen when he calls this the largest story-stock promotion that he’s ever seen.

Oh, and to follow up on another point? Tilson has sold his JC Penney (JCP) shares — he was excited about it as a bet on management last year, with Ron Johnson’s pedigree and the wisdom of the big backers (Ackman’s Pershing Square and the Vornado REIT), but he now says that given their failure to keep the attention of JCP’s core customer group so far it is “too hard” to have the conviction to own it as sales are falling by 20%. I never really got the JCP turnaround story myself, so I have sympathy with the “too hard” statement, it will be interesting to see what Ackman says about it tonight.

So those are my initial thoughts from the introductory seminar — I’ll be sharing more over the next few days, I’m sure, and I’m sure there will be more interesting ideas as I digest the much bigger presentations from the rock stars that take place with the press in the room over the next couple days.

  1. I mentioned it for a Matt Badiali tease almost three years ago:

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