From the 10-drone strike on Saudia Arabia that put 5.7 million barrels of output per day out of commission – the biggest supply disruption in history – to Ron Paul’s latest warning, there’s a lot to unpack from the headlines this week.
But the biggest news for investors may be the most underreported, with only Barron’s and a few other publications beginning to warm to a forecast Dan has been making since 2017 – that the “golden age of value investing” is now in its earliest days.
Dan gets into what a golden age of value investing will look like – and why bargains like his recommendation of Starbucks in August 2018, up 80% in mere months – will become much more common for people who know where to look.
Dan then gets to this week’s guest, Nitin Sacheti.
Nitin is the Founder and Portfolio Manager of Papyrus Capital, a long/short equity fund where he utilizes his short-selling tenets to protect downside for his investors. He is also the author of Downside Protection: Process and Tenets for Short Selling in All Market Environments. Before that, he worked as a Senior Analyst at Charter Bridge Capital where he managed the firm’s investments in the technology, media and telecom sectors as well as select consumer investments.
His firm has made a name for itself by successfully shorting companies even in a raging bull market – and even more uncommon, Nitin doesn’t like to publicly attack his targets, as so many short sellers are infamous for doing to publicly drag down.
Even so, he’s willing to go in depth with his secret to profit from companies’ impending collapses – and in these last gasps of an 11-year bull market, they just may come in handy.
Founder and Portfolio Manager of Papyrus Capital
NOTES & LINKS
2:40: Dan lays out his prediction of a new “golden age of value investing” and how exactly the growth stocks and tech darlings will fall out of favor.
5:33: What would a new age of value investing look like? Dan explains what’s next in the shift that Barron’s is now picking up on too.
10:22: Extreme Value has departed from conventional value analysis in some important ways, most notably the value gauge called “price implied expectations.” It’s led to Dan detecting some hidden gems like Starbucks, up 80% in a few months. Now Dan expects much more bargains to emerge in the next few months.
19:20: Ron Paul’s latest warnings on negative interest rates bursting over a powerless Fed are making news. Dan agrees, with a caveat.
22:30: How could it be that the 10-drone strike on Saudi Arabia put out 5.7 million barrels of output a day out of commission – and markets don’t go haywire? Dan explains why the world is very different from OPEC’s heyday.
27:31: It’s not just Tesla – Dan explains why he hates the idea of investing in just about any car company. “Think of all the money you have to spend before you make a penny of revenue.”
30:01: Dan introduces Nitin Sacheti, the Founder and Portfolio Manager of Papyrus Capital, a long/short equity fund where he utilizes his short-selling tenets to protect downside for his investors. He is also the author of Downside Protection: Process and Tenets for Short Selling in All Market Environments. Before that, he worked as a Senior Analyst at Charter Bridge Capital where he managed the firm’s investments in the technology, media and telecom sectors as well as select consumer investments.
36:12: Nitin explains the edge Papyrus Capital has over other firms in navigating the most treacherous side of investing – short selling, and how it’s survived in this bull market where so many other bearish funds collapsed.
44:56: Nitin’s book on shortselling told Dan something that’s completely counter to everything he’s been told – that valuation actually can play a major role in pinpointing the best shorting wins.
51:16: A company’s fundamentals are one thing – but Amazon and other heavyweights have proved that they can make shortsellers’ dreams come true overnight when they target once-proud companies. Nitin explains how to factor in the 800-pound gorilla into your shortselling strategy.
59:50: The fourth wireless network in the U.S. being constructed in the U.S. is signaling a major disruption in the telecommunications industry – here’s how Nitin sees a major disruption and opportunity shaping up thanks to a looming acquisition.
1:12:15 Dan M. from the mailbag asks our host about a red flag in WeWork’s S-1 filing – a 10-page disclosure about its CEO.
Announcer: Broadcasting from Baltimore, Maryland and all around the world, you’re listening to the Stansberry Investor Hour. Tune in each Thursday on iTunes for the latest episodes of the Stansberry Investor Hour. Sign up for the free show archive at investorhour.com. Here is your host, Dan Ferris.
Dan Ferris: Hello and welcome, everyone to another episode of the Stansberry Investor Hour. I’m your host Dan Ferris. I’m also the editor of Extreme Value, a value investing service published by Stansberry Research. We have a really cool show. I can’t wait to get to the guest today. You’ve never heard of this guy, but I think you’re really going to enjoy him, but let’s get to the rant.
Now, if you read the Stansberry Digest, if you’re a Stansberry reader, you saw me talking about some stuff on Friday, and if you’re a Stansberry Alliance member or an Extreme Value subscriber you also saw me talking about the same thing in the September issue of Extreme Value which came out on Friday as well. So, I was all up in readers’ grills on Friday about one particular subject, and I’m going to talk about that today.
I obviously can’t give away the advice that I told our paying subscribers in the Extreme Value newsletter, but I can tell you what I told them, which I think is extraordinarily important. It’s like this. For a couple of years now I’ve been kind of – well, kind of – I’ve been pretty bearish on stocks. Starting at around 2017 I said, "Look, I expect in the next couple years we’re going to see the start of a bear market and lots of volatility," and after that I said, "We’re probably going to see something like the golden age of value investing."
Because what happens over time, over history, over several decades, you see that the cheapest stocks in the market outperform the most expensive ones for several years, and then there’s usually a bear market or some kind of ruckus. And then people feel burned by the thing that performs so great that let them down so bad in the bear market. Then they switch to something else, so they buy the more expensive names, the high growth technology names, and then those do well for a while. Then there’s a bear market. Then guess what happens? They feel burned by the growth stocks and they go back to the value stocks.
So, there’s this tick-tock kind of change of the seasons effect between growth, the more expensive part of the market, and value, the cheaper part of the market. And so, I’ve been saying stocks are expensive. We’re going to get that moment in the next couple years. It’s coming. It’s not here yet, but it’s coming, and I’ve been talking about it for two years. What I told readers of the Digest and Extreme Value on Friday is what I’m telling you right now. It’s here. It’s started.
I mean, do I even need to recount the last 10 years? You can use the Russell Growth and Value Indexes. They have the Russell 1,000 growth, 2,000, 3,000, whatever. I use the Russell 1,000 Growth Index. That is up more than 400% since March 2009 the last big bottom, and the Russell Value Index is up about 260%, which is nothing to sneeze at, but it’s nowhere near 400%. So, you can see the very obvious difference. People just weren’t interested in value and they loved growth.
What happened on Friday, or I’m sorry, on Monday September 9 is that this whole thing, it turned upside-down like in one day. Our good friend Jason Gefford over at Sentiment Trader kind of called this out to me, not to me personally, he tweeted it to the whole world and I subscribe to his letter and he said it there too to all his subscribers. Basically, he said, “The best stocks today”, that was Monday September 9, “are the ones that have been the worst year to date. This is the biggest one-day momentum shift since 2009.”
I saw another report earlier this week in Barron's and they said basically the same thing, that this shift is the biggest it’s been they said since 2010. But you get the idea, right? Everybody is noticing that there was this massive shift essentially from growth to value in one day, and I’ve been waiting for this, and I’ve been predicting that this would happen.
Now, not everyone is convinced that the starting gun was fired as I’m saying it was on Monday September 9. The Luthold Group is a really great research firm and they were saying, “Hey, don’t get too excited." The Wall Street Journal put out an article saying, ‘Hey, don’t get too excited” but I disagree with them. I think this is it. I think the giant turn I’ve been anticipating from growth devalue is here. So, what does that mean?
Well, think of it this way. If you take all the stocks in the market and split them into 10 pieces based on something like price to book value let’s just say, so you’ve got these 10 slices based on price to book value, so there’s the cheapest 10% and then there’s the next cheapest 10% and so on up to the most expensive 10%. Think of it that way.
Well, for the last ten years, the most expensive 10, 20%, 25%, whatever, has been doing a lot better than those bottom two or three 10%. So, the more expensive stocks have been outperforming the cheaper ones, and that, it just turned upside-down as Jason Gefford indicated and as the folks in Barron's indicated in an article today. If you just type “value” and “growth” and “shift”, you can probably type any combination of these words into Google, you’re going to get a bunch of articles in the Financial Times, like I said Wall Street Journal, Bloomberg has had a couple of them.
This is all over the place. This was not a quiet event. This was a big event. That was the starting gun. That was the moment that I was predicting. I think there’s a couple other things. Really, the one big other thing that kind of caught my eye as a possible indicator is what I’m calling the failure of the WeWork IPO. We talked about this last week. I think that really kind of put a pin in the vision and growth IPO market, right?
Until now, all you needed to have a multi-, multi-billion-dollar IPO was vision and growth, right? A vision of the world with lots of nice flowery language and lots of revenue growth. So, you combine these two things together and that explains a lot of IPOs, right? And of course, making a profit, well, we don’t need that. Vision and growth replaces profitability as the important marker for bringing a company public, but not now.
I think WeWork really – put it this way, who would’ve predicted in January when they were financing, they took a $2 billion investment out of SoftBank at a valuation of $47 billion. Where were all the articles saying this valuation is going to be cut by more than half, and the IPO is probably not even going to happen? There were none. Nobody was predicting that, and yet, that is exactly what has played out.
Now, I wouldn’t have predicted it because let’s face it, this thing has just gone on and on and on for years. Calling the top of a bull market, oh boy, the longer it gets it should be easier to call, but it’s almost harder because we all just get used to it. It becomes the new normal. Well, 2019 is anything but normal. Do you not agree?
Who at January 1 would’ve looked forward and said $1,550 announced gold, seven Chinese yuan to the U.S. dollar. Nobody was talking about seven, it was just six, six, six as far as the eye could see. Who would’ve said May 2019 would be the worst May in 40 years for the stock market? Who would’ve said August 2019 would’ve been the best year for the bond market in 40 years? And who would’ve predicted the WeWork debacle? Nobody is the answer. Of course, I’m sure you’ll all send me feedback and say, “I predicted it” or “This guy predicted it” or “that guy.”
It wasn’t everywhere, and yet, it’s turned into this weird year where all this stuff is happening. Frankly, it feels very end-of-cycle, and I’ve said that many times I realize on the podcast, but it’s become more intense this year with all these huge, huge changes in financial markets. I think for me and for my readers, the switch from growth to value is really the big event. And so, in my newsletter Extreme Value for the past several years we’ve done things completely differently.
We haven’t done the traditional sort of valuation metrics that you do when you’re a value investor. We’ve done some other things and used a different valuation style. I’ve talked about it. It’s kind of complicated. It’s called price implied expectations, and it came from a book by a previous podcast guest Michael Mauboussin called Expectations Investing and it really helped us a lot.
We found all kinds of stuff that by the headline traditional metrics looked really expensive, but when we applied the price implied expectations model it was like, wow, this thing is cheap, and so we recommended for example last August, we picked Starbucks, and that thing was up 80% in a matter of several months. That was from August 2018, by the way. So, it worked, it was good, but it wasn’t the traditional value thing.
What I’m saying now is that the starting gun was fired last week and the traditional value thing is back on, baby. It’s back in action. It’s here. So, our work is cut out for us because if you’ve done any amount of stock screening, you know that there’s a lot more names south of just a couple billion of market cap let’s say than there are north of a couple billion in market cap. So, a lot of these value things are $1 billion, $2 billion, $500 million. They’re smaller, and they’re in beat-up industries, and they’re in difficult businesses.
I’ve been looking at every insurance company, electronics manufacturers. Actually, one was a beat-up utility company. The utilities are screaming, but this one was beat up for different reasons. And so, there’s a lot of different stuff, and each one is sort of a unique situation unto itself. Picking these stocks is a high art because they got a lot of hair on them. You’ve got to be comfortable with a mediocre business.
Starbucks is a fantastic business, and we picked some other big cap stocks like Home Depot and a couple others that I’d rather not give away for free, and they’ve done fine, but assessing those businesses is kind of a similar proposition. They dominate their markets, they generate tons of cash, they have consistent margins, consistent free cash flow. There’s a whole bunch of markers where you can just look at the thing and go one, two, three, four, five, yep, it’s one of them.
But the value stocks aren’t like that. It’s almost like they’re all one-offs, and the only thing they have in common is that they’re all dirt frickin’ cheap and everyone has avoided them like the plague for 10 years. Of course, those two things go together, right? One of the insights that I’d like to share with you is that this is a very Howard Marx type of thing. I’ve recommended Howard Mark’s book The Most Important Thing many, many times on the program, in my newsletter, in my living room to my wife, to my dog.
I’ve recommended the book a lot, and Mark's will frequently say, you know, “The market knows companies. It knows what the good businesses are. So, what are you going to bring to the table that is any better than that? Because you have to do something different over time to get superior returns.” If you’re doing the same thing everybody else is doing, or if you’re doing anything that everybody else already knows about, you’re not going to get the superior returns. You have to do something that everybody doesn’t know about.
And by definition, people don’t know about all the stocks they’ve been avoiding for 10 years, so they’re all dirt cheap, whereas by definition these businesses like Kinder Morgan and Starbucks and Home Depot and other companies, by definition those things, they have eyes on them, so they always look kind of expensive. They don’t really get dirt cheap. So, this is a big shift. It’s a different proposition and it’s somewhat of a prediction because what I’m saying is, from this point forward, the value is going to outperform, but I’m really not thinking of it as a prediction.
I just think the starting gun was fired. It’s absolute historic fact that that one-day shift in momentum is the biggest such shift in 10 years, documented now in two different sources that I’ve seen. I think this is it, man. I don’t know what else to tell you. It’s time to buy value. If you recall, we had Tobias Carlisle on the program a few episodes ago. He’s a classic deep value kind of investor. He’s done all kinds of great research, and he’s got that thing called the acquirer’s multiple.
Well, that’s really just kind of a traditional value screen. It’s really like a price-to-earnings ratio, enterprise value over what he calls operating earnings, or I use the phrase EBIT, earnings before interest and taxes. It’s all about the same thing, and it’s half of – we discussed on the program – it’s half of Joel Greenblatt’s magic formula. Greenblatt used the EV over EBIT and then he also screened by returns on capital. So, he was looking for cheap companies with the EV over EBIT, and he was looking for high-quality companies with high returns on capital.
But Tobias’s research showed that if you get rid of that necessity to have the high quality, the high return on capital, the returns are better over the long run. It outperforms the magic formula. So, what I’m saying is yeah, now at this point we’ve all learned from Warren Buffett, finally we’ve all learned to search out the best businesses just in time for it to be a lousy idea. What does Buffett say? He says, “What the fool does in the end, the wise man does in the beginning.”
Well, this is the beginning of buying the cheap stocks again, and it’s the end of all these things that have just worked gangbusters for the past 10 years including dominant technology companies and just high return on capital businesses, all these wonderful businesses with economic moats and huge competitive advantages. This is a moment when Howard Mark's would say, “If you can’t see this shift happening, if you just can’t see these wonderful businesses underperforming from here, you just can’t fathom it, maybe you suffer from a lack of imagination.”
I would implore you not to do that. It’s the best time of my entire career to become a traditional Benjamin Graham type value investor, and the best way to get started with that is to read chapters eight and 20 of The Intelligent Investor. You don’t even have to read the whole book. Read chapter eight to figure out how to handle stock market fluctuations, and you read chapter 20 to find out about the margin of safety principle and the four principles of businesslike investing, which I believe we’ve discussed in a previous podcast.
I don’t want to do them now because I want you to read that chapter, but that is really the way to get started, and I hope you do it. Look, if you want to subscribe to Extreme Value I’d love for you to do that, but I’m not the kind of person who’s going to pitch the thing hard at you. It’s an expensive product. I don’t want people who are going to sign up and cancel. I think we have a website called ExtremeValueOffer.com, and most of the time they have an offer up there. If you’re interested, go there. If not, hey, let’s just be friends and talk on the internet, OK?
So, that’s the rant and write in and tell me what you think at [email protected] Now I’d like to talk about what is new in the world. One thing that’s new in the world, I haven’t seen Ron Paul’s name in the news for quite a while. The, I believe, now former congressman is a famous – he’s probably the most famous libertarian guy in the world, and his son Rand Paul serves in Congress today.
They’re libertarian guys. What can I say? You know what libertarians like. They like the smallest possible government and the least possible taxes, etc. Paul is out in the news. He’s saying what you and I have discussed and what I’ve discussed with previous guests, U.S. interest rates are going negative. He thinks they’ll be negative; others have said that as well. He said the Fed can’t stop it. He says we’re in the biggest bond bubble in history. We’ve talked about that, haven’t we? And it’s going to burst.
Hey, the “going to burst” thing is actually I think a somewhat slightly controversial viewpoint. I understand it. Cycles matter, but here’s the thing, you can’t predict how long interest rates will stay low or how long they’ll stay high or when they’ll turn. I said in my rant today that it’s a weird year and it feels like a very end-of-cycle kind of year. I don’t know that that means interest rates are going to go up by any great amount. It wouldn’t surprise me if they did, but nor would it surprise me if they stayed low.
Believe me, in my newsletter over the years I called the top of the bond market a couple of times and I got tired of doing it, and I’m not by any means the last bear. They say when the last bear is gored, that’s the top of the market. There are plenty of those around today. Today we’ve got – there are different numbers floating around. There’s an indicator on Bloomberg that you can look up.
The last time I looked at it, the peak was $17 trillion of negative yielding-bonds in the world. Most of them are European sovereign debt. Let’s see, I think the last time I looked at it, it was like a week ago, and it was maybe just under $15 trillion. Interest rates take a little tick up and that number takes a little tick down. Hey, maybe a trillion here, trillion there, you’re talking real money, but I say what’s a trillion between friends? $15 trillion is a lot, and I think Ron Paul makes a good point about U.S. interest rates, and it won’t surprise me at all if U.S. rates go negative, period.
So, let’s talk about this Saudi oil thing. Over the weekend, drones attacked Saudi Arabian oil infrastructure, a processing facility, and put, so we were told, maybe 5.7 million barrels of output per day out of commission. Biggest supply disruption ever in history, and Bloomberg was running a graphic that showed other supply disruptions, various wars and events in the Middle East and things, and it’s interesting to me how much of a – I don’t want to call it a non-event because oil was up like 15% yesterday.
At one point it was up as high as 15%. The futures ended the day I think up 12 or 13%. That’s a huge move in oil, but the world is different now, and that is something that we have to remember. The U.S. is the biggest producer now. Saudi is the biggest exporter still, but the U.S. is the biggest producer now, and U.S. exporting has begun and it’s legal now. Things are different, and it wouldn’t surprise me at all if this were less of an event than people are kind of talking about.
Some people are saying, “Well, this disruption can go on for a while. Oil prices could go up even more.” That’s not my view on this. I don’t care who did it, and certainly if President Trump is convinced that some country or another did it, like he’s saying Iran maybe did it, the news reports say Yemen took responsibility, but Pompeo our U.S. Secretary of State and Trump too in tweets and things, they’re blaming Iran.
So, not sure what all this means. If it means war in the Middle East, well, that could be a bigger disruption. That could cause the price war to go higher. I don’t know, and I thought actually the response from gold was kind of – I thought gold might be up $40 or $50 or something on Monday and it wasn’t. It was up like 1% or so. It was, I don’t know, $15 or $20 or something like that, if that much. It’s just a sort of keep your eye on it kind of a thing, but I don’t know if it’s as big a deal as everyone says.
OK, Bob Iger next in the news. Disney CEO Robert Iger has resigned from the board of directors of Apple. He was on the board of directors of Apple and now he’s resigned, which makes a lot of sense now that Apple has formally unveiled it’s Apple TV+ subscription streaming service, which will obviously compete directly with Disney’s forthcoming streaming service. Everybody has a forthcoming streaming service, don’t they? Everybody is going to quit all the boards they’re on.
And so, it’s not a huge event, but it’s something that just kind of shows you that this is serious. It’s going to become a bigger, more ferociously competitive thing than it already is. My old friend Frank Curzio is tweeting about it and he said he’s covered tech for decades. Every major technology change of the past couple decades, never seen so many giant technology companies trying to storm into something that makes little or no money. Anyway, again, that’s kind of a wait and see type of a thing.
We’ve talked about GM a few times over the years or really over the past several months for me on the podcast, but Stansberry has talked about it over the years. Porter has talked about it. They had, what, 46,000 employees who are members of the United Auto Workers walk off the job 11:59 p.m. Sunday. This is like the first countrywide, nationwide work stoppage since 2007. I mean, this feels like a headline from my youth or something. I was a teenager in the 70s.
This strike impacted 52 facilities in nine states. No cars rolling off the lines. GM daily earnings losses could hit $50 million per a report by Credit Suisse. So, UAW is sitting on $850 million in the strike fund, and they’ll pay the strikers $250.00 a week, so they’re kind of dug in. Who knows how far this goes? If you own GM stock, which I wouldn’t have done anyway, you’re probably not real happy right now.
How does it come out? I don’t know. I hate car companies. I hate the whole idea of investing in a car company. Every now and then you could probably pick a bottom, maybe if they wind up in my dirt stinking cheap 10 percent of the market, I’ll think about it, but it’s like high super capital-intensive businesses. Think of all the money you have to spend before you make a penny of revenue, and that tells you the bigger that number is, the lousier the business, and usually the more competitive it is.
They can sort of ill afford having almost 50,000 people walk off the job and dug in for quite a while with $850 million in their strike fund. So, it’s just a horribly competitive, low margin, high capital-intensive business, and now it’s having this kind of problem which is typical. Union problems are typical of high capital intensive, low margin, highly competitive businesses. It’s one of the things you find and one of the reasons why I try to avoid them.
Like I said though, these days anything can be dirt cheap enough, but this thing will have to drop a lot more for me to get interested. Even then it’s so massive and the liabilities are potentially so harmful. I don’t know. I don’t know if I’d ever touch it. There are some things that you just never want to touch.
Hey everybody, I just want to tell you real quick about one of my favorite times of the year where I have a lot of fun and I learn a whole bunch of really good stuff, and that’s at the Stansberry Conference in Las Vegas. One of the things I love is just we find an incredible number of really high-quality speakers that we pack into this conference. Now, the tickets for the conference are sold out, but you can still see all the action with live streaming.
I’ve actually livestreamed conferences put on by some of the people that are going to be speaking at our conference, and I love it because you can go back and watch the presentations over again and get all the details you might’ve missed the first time. So, you can stream the Stansberry Conference for $399. You have to hurry up. They tell me the prices are going to go up as we get closer to the conference in a couple of weeks here.
So, just go to www.investorhourstreaming.com and you’ll see Dennis Miller, Noriel Ribini, Jim Grant, Marc Cohodes, George Gilder, just to name a few. Don’t forget of course your favorite Stansberry folks like Porter, Doc, Steve, and your favorite of all, me, Dan Ferris. That’s www.investorhourstreaming.com to sign up.
Today’s interview guest is Nitin Sacheti. Nitin Sacheti is the founder and portfolio manager of Papyrus Capital, a value-oriented long short equity hedge fund. Prior to founding Papyrus, Mr. Sacheti was a senior analyst principle with equity contribution at Charter Bridge Capital where he managed the firm’s investments in the technology, media, and telecom sectors as well as select consumer investments.
Previously, Mr. Sacheti was a senior analyst at Cobalt Capital and Tiger Europe Management, pretty cool, managing mostly the fund’s non-European investments. He is also the author of Downside Protection: Process and Tenets for Short Selling in All Market Environments. Mr. Sacheti began his investment career in 2006 at Ampere Capital Management, a consumer media, telecom, and technology focused investment firm initially as a junior analyst, later becoming assistant portfolio manager.
He graduated from the University of Chicago with a B.A. in economics and was a visiting undergraduate student in economics at Harvard University. Nitin Sacheti, welcome to the program, sir. Thank you for being here.
Nitin Sacheti: Thank you so much for having me.
Dan Ferris: Yeah, so I usually start out asking folks who are in your line of work who actually handle other people’s money, at what age did you become aware that a career in finance was for you? When did you start thinking about that?
Nitin Sacheti: That’s a really good question. So, I would say it was in high school. I had a phenomenal, phenomenal economics teacher who actually taught, Henry Kravis economics two, and he sort of attributes his career to this particular teacher and I do the same thing. I think what really engaged me was just sort of all of the information behind the decision-making and kind of the logical steps around sort of economics and business and how that affected the world and how the world works.
And so, I started off in high school reading The Economist and I fell in love with the magazine. Then I started to get interested in the stock market just sort of as a way of kind of manifesting that knowledge that I was learning. And so, I think it was sort of putting all of that together that made me interested in businesses and how businesses operate, how they change, predicting how the world changes and how businesses are affected by that over the corresponding or the next several years, and that was right around the internet boom and sort of what that was doing to valuations and the overall kind of business landscape.
Then on top of that, in high school I started the investment club with a couple friends. We tried to use our real money investing. I ended up doing the same thing in college, founding the investment club where we had a pool of money and everybody contributed and we researched businesses. So, it was really along the way. I laugh because I knew so little then versus now, and I’m sure I’ll probably say the same thing in 30 or 40 years, but yeah, for me it was just kind of the intellectual curiosity and watching the world change around you that captivated me in terms of finance and in terms of investing.
Dan Ferris: That’s really cool. A high school economics teacher kind of inspired you. Tell me about where you are today. What specifically, when I was reading your intro and I saw Tiger Europe, working for Julian Robertson’s firm Tiger must’ve been really exciting, right?
Nitin Sacheti: Yeah. One of the most interesting and kind of the best takeaways for me from Tiger was really that I was in 101 Park with 30 other Tiger seed funds. The floors were comingled to some extent, so there were just so many intelligent people who had really different business backgrounds before they got into the hedge fund business. There were guys who were in sort of the casino business before they were in the hedge fund business, and when I was looking at a couple online gaming stocks, I could walk over to them and get sort of a real education on the business from somebody who was in the trenches.
And so, I think that was a great value of Tiger was just being around so many smart people and how welcoming and how team-oriented the environment there was. Then on top of that, I think Julian had sort of a real focus on feet on the streets research, and I think that permeated into all of the seed funds too. And so, the value for me from that perspective was I would say before I joined Tiger, I was sort of sitting at my desk reading filings, reading research, news reports, but I really wasn’t going out into the field.
I talk about this a lot in the book, and I feel like that really shaped my perspective both on the long and the short side but particularly on the short side, because I feel like to be a great short seller and to really know a business well, you really need to get out to those industry conferences, work the floors, talk to 30 people from 30 different companies who are all tertiarily involved in the industry which you’re researching in order to develop a real perspective rather than just sort of hearing the company line that management is telling you. That broadened my perspective and that was just an incredible takeaway from working at Tiger.
Dan Ferris: It sounds to be like what you might say "your edge" and what you do different at Papyrus is this sort of scuttlebutt feet on the street kind of a thing. That has to be a huge part of Papyrus, right?
Nitin Sacheti: Totally agree. I would say any edge can never be one thing, otherwise it’s too easy to replicate. I would say the edge for me and for Papyrus is really a few things. I think you hit the nail on the head. I think that’s the greatest edge for me is really the depth of the work that we do, but I think on top of that it’s really the temperament. I think a lot of the shorts that I discussed in the book, we were probably the first half of the time we were invested in them we were losing money. In a lot of cases we were losing 30, 40, 50%.
So, I think there’s something to be said about patient investors and being patient and having a great temperament yourself to really put up with the volatility to sort of watch situations play out, and I think this is sort of an overarching answer to the question too though is that we’re seeing so many funds closing down. We’re seeing such moves to passive. We’re seeing kind of fundamental active management not working as well, not really beating the S&P as well as in the past, and I think that that’s obviously a function of just so much around distortion from central bank easing, which you know as well as I do.
But I think having that temperament and having that very long time horizon to sort of hold onto a really good business coupled with doing the really deep fundamental work to know that that business will be around, will thrive, will have a great management team that reinvests capital very effectively, to sort of see value grow over time and put up with the short-term volatility from what happens with the noise around the stock market. I think that’s really the edge for me is sort of putting all of those things together.
Dan Ferris: So, it sounds like you’re selling learning and you’re selling patience, and let’s face it, it’s just plain old intestinal fortitude in some of the drawdowns.
Nitin Sacheti: Yeah, I think you’re right. I think it’s having the guts to kind of stick through the ups and downs, but I think that confidence comes from the depth of the work. I feel like I wouldn’t necessarily be as confident in our positions and putting up with 20 to 30% drawdowns in a single name if it weren’t for that feet on the streets work that you mentioned earlier.
Dan Ferris: So, let’s talk a little bit or even a lot about your book. I’m not done with it yet, but I’m really enjoying just kind of going over all the tenants of short selling that you discuss in the opening, and then of course you have lots of case studies which are a little different, and we’ll get to that too. I want to bring Mike Barrett in because he really turned me on to your book. Mike, is there some question about this book that you want to ask Nitin that is just eating you up inside?
Mike Barrett: Well, you know, Nitin, I really enjoyed the process. I’m always interested in finding out how other people approach this investing thing that we do. As a trained engineer, for me it’s all about process and always has been, and so I’m always looking to improve that process, and so that’s why I was really intrigued with your book. I’ve put it out there to our file a couple of times as far as a recommendation.
I do have one question before we get into the details of it. I was curious about the extent to which you consider short interest or the degree to which other people are short a stock into your process. I don’t think you mentioned it in the book, and that’s something we typically pay attention to. If investors are 30 or 40%short a stock, we may back away from it. Does that affect you at all?
Nitin Sacheti: I think that’s a really good point. I would say there are two ways at least from my perspective, there are two ways in which high short interest sort of affects a stock. I would say one, that’s the borrow cost, and I think there are obviously a lot more long short funds now and there’s a lot more long short money chasing, sort of well known or well telegraphed shorts today, and so I think that sometimes causes the borrow cost to go up.
So, that’s the first thing, and then I think the second thing is just volatility around a squeeze. I think your incremental short seller might not be the one with the temperament to sort of hold through the drawdowns or maybe they’re not the one who has done the deep work to kind of hold through the drawdowns on a good quarter or two the company may post. And so, I think that sometimes causes pretty violent squeezes in a stock. So, what I would say is the first is a definite concern for us because it actually fundamentally affects our returns.
And so, if the borrow cost is very high, and I think the one thing I did allude to in the book around borrow cost is that I was short Go Pro in 2013-2014. When we shorted it, the borrow cost was 90%, but the lockup was also expiring a few weeks later. We were short Beyond Meat earlier this year, and the borrow cost was very high there too, but again, the lockup was expiring and the only follow-on that happened where the underwriters waived the lockup period really brought the borrow cost down.
So, if I think that high borrow cost is temporary then I’ll still short the stock even if short interest is high, but I am definitely very – we don’t share too many of our shorts for that reason just because I don’t want the thesis to get out there and I don’t want the world to start shorting the same stock and increase the borrow cost for me because my fiduciary responsibilities is to our investors, and that really affects their returns. So, I am conscious of the first and the high borrow cost.
In terms of a volatility, I think that’s something that I’m not worried about. If the borrow cost is low but the short interest is high, I’m still willing to short it if I think it’s a great thesis because one, like I mentioned in the book, we shorten small size. Two, I think our temperament is very long-term and our focus is very long-term. So, the volatility, I just look at that as a mark, not necessarily an impairment of capital. So, the latter doesn’t really cause me not to show a stock with a high short interest.
Dan Ferris: Wow, that’s a great answer. So, Nitin, I’m going to pick your brain as much as possible here because you have a lot of experience. Is it unusual in your experience for underwriters to waive lockup periods? I didn’t even really understand the nature of a lockup as an agreement with underwriters before Matt Levine wrote about it recently.
Nitin Sacheti: It’s so fascinating that you said that because that’s actually something I’ve kind of asked our attorney to look into, because I don’t know if it’s legal and to be honest with you, the answer is I don’t know, ‘cause I don’t know the answer to that yet. The first time I had seen it was with Beyond Meat and I was just really surprised, and I wondered, first question I asked myself when that follow-on came out was is this legal?
And so, for us, my timeframe was, OK, the borrow cost is X, but the actual lock-up will expire at this particular time. And so, the hurdle is significantly lower with the lock-up expiring four months before we shorted it, that the hurdle was one-third of the annualized borrow cost. And so, for me, that hurdle was sort of enough to short, but then I would say we got lucky with the lock-up expiring early. But I don’t know the answer to that yet, but I’ll follow up with you on it once I do figure it out.
Dan Ferris: OK, thank you. That’d be great. So, I want to dive into the book, and I’ll tell you, I like to be shocked and I like to be surprised, and it never ceases to amaze me that somebody who’s done as much work as you have let’s say on short selling says something that is completely counter, completely opposite of everything that I’ve been told. The same thing happens to me. I learn all about something and I say, well, this is completely different than everybody told me.
I’m going to read a sentence from your book and tell you what I mean. It says, “I believe innovators dilemma shorts at high multiples on peak earnings are the best type of shorts” and what shocks me there is that you mention valuation prominently as one of the characteristics of the best type of shorts. You know what everybody says. What do they say? They say valuation is a bad way to figure out a short. Valuation shorts are terrible, and I realize there’s another ingredient here, but I was just shocked to see valuation as one of the two characteristics of the best type of shorts.
Nitin Sacheti: Yeah. Thank you. I guess what I would say is that for me, I mean like we talked about with longs, you really need downside protection, and you really need to make sure that – it just goes back to the original Graham Dodd philosophy, something that _____ talked a lot about where you want to make sure that you protect the downside and your upside will take care of itself. I think it’s sort of the same thing on the short side but reversed where if you have a high valuation and it’s on peak earnings, then the stock has a lot of room to go down, right?
If you have a low valuation on peak earnings, maybe your earnings declines and your stock drops at the same percentage as your decline in earnings assuming the multiple stays constant. But the reason why I love these innovator dilemma shorts where valuation is high and that high valuation is on peak earnings is there’s really two ways to win, and if you can prove through the work that this is actually peak earnings, then clearly the multiple will contract also.
So, again, going back to downside protection or capping your upside on the short side, the exact opposite, my point in why I like these shorts is because if you’re at sort of peak valuation, if you’re at when I talked about fusion IO at 50, 60, 70 times forward earnings, my take on that and that being on a peak earnings power, then it’s hard to lose money in the short run while you’re waiting for the thesis to play out. It’s hard to see that the multiple will expand any further.
Then again, if you’re right on earnings, when earnings drops, the multiple pretty much in every situation will drop with earnings because the street was over extrapolating that high earnings into the future and putting a growth multiple on that earnings stream which they deemed to continue to grow.
Dan Ferris: I have to say, even as you describe it, it still sounds really gutsy to me to say, well, we don’t think the multiple can grow anymore because you never know how crazy something can get, right?
Nitin Sacheti: I think that’s why the amount of work and the depth of the diligence and kind of modeling the business is so important, because you really need to prove that this is peak earnings. I think that if you can prove that and earnings does decline, and that’s why I say it’s these innovator dilemma shorts because the innovator dilemma sort of assumes or concludes, it’s an innovator’s dilemma issue if you’re concluding earnings will decline, right?
Because what is the definition of an innovator’s dilemma? It’s a company that was a first mover that was over earning and better capitalized competitors come into the market and effectively compete away that over-earning that the innovator essentially did, which is why they’re hitting this dilemma, right? So, that essentially entails a drop in earnings, and so I think if you do see that drop in earnings then, yeah, I think the stock should decline.
Now, that said, one of the other things I discussed in the book was looking at the metrics that the street is also focused on. I used the example of something like a Tesla or something like a Stitch Fix or a Netflix where – and we’re short both Tesla and Stitch Fix. So, Tesla for example, the world is not looking and consensus is not looking at the earnings power, right? They are looking at the number of cars that the company is selling every quarter.
For Stitch Fix they’re looking at the customer growth, not the earnings power generated by those customers even though when you look at the amount of marketing spend that Stitch Fix is spending on a particular customer, that marketing spend is greater than the value that they generate, the cash flow that they generate from that customer over the life of the customer. That essentially tells you that every customer acquisition they’re doing is actually destroying value which is fascinating to me, that people still focus solely on customer growth.
I think that’s changing now, but the point is that yes, we are looking at peak earnings on a peak multiple, but there are still other factors like – that applies to the names where like a Fusion IO or like an Invent Sense that I discussed in the book where the market is looking at earnings. I think in the case of something like a Tesla or something like a Stitch Fix, you have to look at that other metric on top of peak earnings on peak multiples.
Dan Ferris: I see. So, when people ask me what the innovator’s dilemma is, I say, well, Microsoft and Amazon are dying for you to tell them what industry to take over next. So, just have a great idea, bring the company public, have it grow real fast and don’t make a penny, and then they’ll take over and make gobs of cash doing it.
Nitin Sacheti: Yeah, I totally agree with you. That’s why one of the tenants was pay attention to the 100-lb. gorilla in any industry, and I think that’s so much of my work is looking at what Intel is doing in semiconductors. Like you said, it’s looking at what Amazon is doing.
I mean, almost every industry out there now, again like you said, Microsoft, it’s all of the big companies and how they’re affecting their particular industry, or it’s even smaller semiconductor companies again on the theme of sort of an Invent Sense or a Fusion IO. It’s these smaller semiconductor companies that are sort of mid-size in the industry, have their own manufacturing, the lowest cost of production, and when they’re getting into a new space in innovating one of these former innovators, I think that’s exactly the same thing.
Dan Ferris: But still overall, I return to the gutsiness. I realize you’re leaning on deep research, and that’s the point that I think we need to make, but for me, what I lean on, tell me if you do this, what I lean on heavily in that way is when I get – usually it’s like even a smaller cap company, but when I feel like I’ve known the management for years and years and I can count on their behavior through the cycle, and at that moment I get really confident.
Nitin Sacheti: I totally agree with you. And so, I would say if our process on the short side is my book, our process on the long side is essentially Will Thorndike's The Outsiders. And so, we really look for on the long side we’re looking for great management teams that we think have a real history of capital allocation and are really building value like you said through cycles.
I’ve spent a lot of time with the management teams at Liberty, John Malone’s businesses, and we’re invested in a few and so I go out to Denver and meet with them whenever I can a few times a year. Same thing with Charlie Ergen and EchoStar and Dish. I think these are just phenomenal management teams that really have a very keen eye for capital allocation through the cycles like you said.
So, I think the value, we’re also invested in a smaller cap called Hemisphere Media, HMTV, and that’s run by Alan Sokol who ran the Hispanic media strategy at Leo Hendry’s private equity firm. Leo Hendry was the CEO of TCI; while Malone was chairman. And so, these are very, very smart people who have been trained well basically by the best, and we are so comfortable like you said on the long side.
Even if the stocks don’t move up with the S&P in the short run just given everything that’s happening with QE, I look at these businesses and I think they’re trading at great multiples, they’re run by great management teams who can steer these businesses through cycles. They’re going to accrue cash to the balance sheet at the top of the cycle, and I have to just not worry about the fact that they’re underperforming and understand that when the cycle turns they’ll deploy that cash very creatively and over a 10-, 15-, 20-year timeframe like you know, _____ highlighted. These companies generate consistent value with a lot less risk, so I totally agree with you.
One thing that I talked about in the book and I mentioned about Tiger was really the feet on the streets research and just how many of the management teams on the short side that we speak to essentially, I hate to say it, but they basically lie to us about the future.
When I’m confident with a management team exactly like you said and I’ve known them for a long time and I know that they’re very honest and very direct, it’s a lot easier for me to take what they’re saying and sort of model what they’re telling me, which again like you said is just so much more comfortable. I think so much of our business is differentiating between when somebody is telling you the truth or not and digging to kind of figure out the truth.
Dan Ferris: So, I don’t want to give away too much of the book, so maybe we can just kind of shift. Do you have a particular long idea right now that’s like your favorite long that you feel like talking about?
Nitin Sacheti: Yeah. One of the longs that we really like here is EchoStar. This is the smaller of Charlie Ergen’s two companies, and so EchoStar, the ticker is SATS. This is a business that does rural consumer broadband satellites. You’re in the Catskills and you have essentially either DSL or you have no real wired broadband connection. Their satellites will allow you to get 25 megabits per second in internet so you can stream, watch videos which you otherwise wouldn’t be able to do. So, it’s a very rational duopoly between them and Viasat, as that was one of Biopost’s larger equity holdings on the same thesis. I think SATS is more interesting than Viasat given the valuation difference.
So, essentially the business generates very good IRR, sort of low and mid 20% IRRs, just based on the fact that it’s a rational duopoly and they have about 1.5 million subscribers on the two satellites that they have up and running right now, and the addressable market is call it 12 to 15 million households in the U.S. that are sort of in the low end of DSL footprint or have no ability to get any sort of fixed broadband service. That’s not really changing, just given the very high cost to build out whether it’s wireless or it’s wired to any of these places.
So, I think those IRRs are very good and they’re very stable, and this is a business that is underperforming or has underperformed for a few reasons. One, they were trying to do a large acquisition so they took out a lot of debt and so they had a very overcapitalized balance sheet, so call it $3.5 billion or so market cap and they had about $2.5 to $3 billion in debt on the balance sheet and about the same in cash. And so, it was essentially a fairly lazy balance sheet.
People were upset that they took out this debt and they didn’t do anything for a few years, so that was sort of one of the reasons of underperformance. The second was that they had a division that was essentially satellites that sold service to Dish Network for their TV customers. So, that particular business, the majority of its revenue came from Dish which people saw as a sister company, and so they saw high revenue concentration and they saw sort of dealing between two entities controlled by Charlie Ergen.
So, I think reasons why the company is sort of misvalued now, the reason for the misvaluation sort of start going away as it has the last month or so, or started to in the last month or so, is because one, Charlie essentially sold that business, the business that sold the satellite service for television customers to Dish, and so shareholders of EchoStar were distributed Dish shares, so those shares were distributed late last week. So, what that did was it shrunk the size of EchoStar and it took out that business which was a non-growth business. So, it isolated just this consumer broadband satellite business that I was telling you about.
And so, now the company is a lot smaller and the growth rate is a lot higher, so you’re essentially paying about five to five and a half times EBITDA or what I would say is about eight to nine times free cash flow on maintenance Capex. So, obviously they’re spending on these satellites and those satellites are generating very high IRRs for them, so if you strip out that mean satellite spend and you just look at the spend they would need to kind of keep their current customers and slightly grow, the stock is trading at eight to nine times free cash flow. So, it’s very, very cheap for a good 12 to 15% revenue caper over the next five years.
Now, the other side to the story that I think is really interesting here is as most people know because it was on the front page of the Wall Street Journal a month or so ago, but Charlie Ergen is building a fourth wireless network in the U.S. He’s doing that through Dish Network, and the reason why that was on the front page of the Journal is because the Sprint/T-Mobile deal essentially went through because Charlie met with the FCC and Sprint and T-Mobile divested some of their business, their prepaid wireless subscriber business to Dish and to Charlie, and that was sort of what allowed the merger to go through the DOJ.
Now Charlie is so focused on building this wireless network through Dish that I think there’s a very high chance that he sells EchoStar to Viasat. I think that because he shrunk the size of it by moving that set top box business and the satellite business that sold satellites to Dish that I mentioned, because that went over to Dish, the size of the business is a lot smaller, which makes it a more likely acquisition target for Viasat because they can actually sort of take it out without financing that they can’t do.
And so, I think that the synergies in a deal like this are so large, and I think that this industry is still sort of under the regulatory radar so that I think a deal would go through. I think Charlie is willing to part with it because he’s so focused on Dish. What do I think the business is worth? I think that at something like 12 to 13 times free cash flow, and they also have some hidden assets in Mexico and Latin America that are just starting to generate. On the South American side, they’re just starting to generate earnings, and the Mexican asset is unconsolidated and is probably worth another $10 per share on a _____ low 40 stock price.
So, I think something like 12 times free cash flow plus the value of some of these hidden assets along with Spectrum that they own in Europe that’s not really being utilized, the stock is probably worth $75 from low $40’s today. I know that was a lot of information. Hopefully I communicated that properly.
Dan Ferris: No, that was great. In fact, I want our listeners to know this is what somebody sounds like when they’ve done – Nitin talked about doing deep research and we took him at his word, but now we know he meant it. So, Mike, do you have anything to throw in here?
Mike Barrett: No. I had one other thing that I wanted to mention about the book if that’s ok.
Nitin Sacheti: Yeah, please.
Mike Barrett: Or just throw out there to discuss real quickly. Go back to process and the problem with short selling, what makes it difficult in my opinion is that there’s always tension in the process. There’s all of these things that you look for, and you do a very good job of laying them out in your book of the things that you want to look for, and you look for those things and you find them and invariably one of those things is in contradiction to the other things. I think the thing that I often come back to is the one thing you mentioned is don’t short a product that customers love.
Oftentimes I find that Netflix is an ideal example I think of a stock where a lot of the pieces fall into place, but what do you think here about Netflix? Is that a product that customers still love to a degree that you wouldn’t short the stock?
Nitin Sacheti: I mean, I think Reed Hastings is a really intelligent guy. When I was in Denver, Charlie Ergen essentially said the same thing. The guys at Liberty have said he’s a very, very smart guy and he’s just really changed the industry. I think that he is a phenomenal – he runs a phenomenal business and he’s built an incredible business, and he sort of understands what people care about in terms of his stock and what they don’t care about. He kind of understands the market and the environment with QE and sort of what he needs to do to build the right business.
He’s essentially changed the world, right? And so, it’s hard for me to short such a visionary, the business of such a visionary, because I think he’ll continue to sort of pull a rabbit out of a hat which he has done, so that’s one thing. The second thing I would say is I guess the problem I have, and I look at the Walmart/Amazon example as exactly the same thing. I was thinking about this, this morning, actually. You look at Walmart, and I know this is a little bit of a tangent, but hopefully it proves the point.
You look at Walmart, you look at Jet and what they did there, and you look at Amazon, and the market just views Amazon so differently. They don’t view it as an earnings power story for the reasons we were discussing earlier on Tesla and Stitch Fix, and yet they view Walmart as an earnings power story. So, when Walmart does big acquisitions and they effectively dilute their earnings power, you saw the stock go down. I guess it’s very hard to retrain investors and sentiment especially in sort of a speculative market like this.
I guess my issue, when I think about that and I think about Netflix and I think about all of the other media companies that are sort of the older media companies like the Discoveries of the world, and how they are valued on an earnings power basis, I think it’s hard to short Netflix because they can do things that these other media companies can’t necessarily do in terms of spending money.
It came out yesterday that they got all 180 episodes of Seinfeld, and I just wonder, I look at the first thing I thought of when I saw that was how much did they pay for that? Just given the parties involved and how much they have a vested interest in seeing Netflix fail. So, it’s sort of like maybe Netflix paid so much and on $11 billion in revenue they’re spending just about 100% of revenue on concept, and no other media company can really do the same thing.
So, I just wonder if as they’re growing their international subscribers, I can’t predict when the international subscriber growth will start to decline, but what I can tell you is that I feel like there are a lot of challenges to shorting that because they’re doing things that other people in the industry can’t do because they haven’t trained their investors to do, and they’re very focused on their stock price and their earnings power. So, I don’t know.
I personally feel like there are easier shorts out there than trying to game exactly when Netflix subscriber growth will subside because I think the market will continue to just look at that, and they’ll continue to do whatever they need to and are sort of given the leeway by their shareholders and by the street to continue to just grow subscribers regardless of the spend involved. I would say for me, there are easier shorts out there than Netflix.
That said, let’s compare that to Tesla which is a business similarly that’s valued on cars sold, not on earnings power just like Netflix is on subscribers. I would say for me, that’s a much easier short just because again it goes back to the competitive angle. On the Netflix front, yes, you’re seeing Disney try to do something with Disney streaming and you’re seeing AT&T try to do the same thing with the Time Warner asset that they acquired.
I just don’t know if they’re ever going to be able to spend the kind of money that Netflix has to really build out that streaming platform because it massively cannibalizes the rest of the businesses. Whereas when you compare that to the Tesla example, I don’t know about you guys, but six months ago I went and I test drove the Hyundai Kona EV, and that car was incredible. It basically drove exactly like a Model S, and it’s $40,000 and with tax credits it’s $29,000 or $30,000 in Connecticut where I test drove it.
And so, I look at that and I think it’s not Tesla, it’s electric vehicles. I think as soon as you see a few more competitors sort of like what you’ve seen in terms of the reviews of this new Porsche EV. I think that the next two years as you have so many more electric vehicles on the market from better capitalized competitors at lower prices, Tesla is not going to fare very well, and I think it’s a great short.
But on the Netflix front again, I don’t know if you’re really going to see the other media companies really steal share on the streaming side from them, which means then it becomes a game of predicting when they saturate the market, which I think is not very predictable.
Dan Ferris: OK, Nitin, we’re coming to the end of our time here, but I have to say, you pack a mean punch, man. You really provided our listeners with a lot to think about. My last question, if you could leave them with just one thought if I could ask you to do that, what might that one thought be?
Nitin Sacheti: All right, I’ll keep that one thought short since my answers have been pretty long so far. I would say there’s no reason to force an answer. I think we’re in an industry, I mean Buffett says it best, this is the kind of industry where you can kind of wait for the fat pitch. I would say that there’s no – sometimes we force ourselves to have an opinion and we force ourselves to come to a conclusion, and I think investing is the sort of business where you have to sort of realize that so many things are out of your control and you’re never going to have an opinion on everything.
The sooner you can sort of come to realize that you can’t have an opinion on everything and some things are just unknowables and you should just pick up and move on to the next thing I think is what drives in my opinion success in this industry because then you can focus on what you can prove and what you can predict, and you can put stuff into the “too hard” pile and pass on it. I think any time when I look at my mistakes in the past they’ve been in situations where I tried to force a conclusion or force an answer versus just stopping and telling myself “I just don’t know” and moving on.
Dan Ferris: OK, that’s a wonderful thought to be left with. Thanks for being here, man. I hope we can get you back in the future sometime. It’s been great.
Nitin Sacheti: Yeah, same here. Thanks for having me. I appreciate it.
Dan Ferris: Thanks very much and we’ll talk to you again hopefully soon.
Nitin Sacheti: Sounds great. Thanks, guys. I appreciate it.
Dan Ferris: OK. Bye-bye, Nitin. That was really great. That guy packs a punch. That’s what you sound like when you know what you’re talking about. Man, with that, let’s go check out the mailbag. So, the mailbag is where you and I get to have a conversation every week. It’s kind of fun. I read every single e-mail that you guys send me, and I have a lot of fun doing it, and I’ve picked out some of them that are kind of fun this week, so let’s get to them.
Dan Ferris: Now, of course, I did these rants about WeWork last week, and I did another one about Peloton the week before that, remember? So, we’ve got a little feedback about some of those. Now, the first one is from John M. and he says, “Dan, many thanks for your podcast, and I especially liked your recent rant about WeWork and CEO Adam Neumann. I have been reading numerous articles about them with amusement, and in my opinion the biggest red flag was in the S-1 filing.
When a company has to include 10 pages of disclosures about its CEO, one has to wonder. And this was before the news came out about him selling the domain name to his own company. Here is my question. What is the difference between WeWork’s business model and that of a well established profitable real estate company such as CBRE?” That’s CB Richard Ellis. “From what I can tell, CBRE buys and rents buildings while WeWork rents work spaces and desks. Am I missing something? John M.”
Thank you, John. First, a couple of things. The S-1 filing John referred to is the IPO prospectus that every company has to file with the SCC if they want to go public. Next, I don’t think you’re missing anything. WeWork is the one who is renting those buildings from people like CBRE. They’re the ones taking on the 15-year leases, and their customers or tenants or whatever they’re called, subscribers or members I think they call them, they’re taking advantage of this highly flexible model that WeWork has.
So, when the recession hits, CBRE is still going to be collecting rent. Things won’t be perfect. Real estate does have its problems in a recession, but who’s going to come out better at the end of it, CBRE or WeWork where all of a sudden tumbleweeds are going to be blowing through the buildings because these people have no obligation to go past the next 10 minutes or 30 days? So, you’re not missing anything, John. That’s exactly the way it is.
Next question. This one is kind of long. I won’t read the whole thing, but it’s a very thoughtful e-mail and I like it when people write in who have real experience about something I’ve talked about. So, this one is from Steve B. and Steve B. says, “Dan, I’m an original Alliance member, regular listener to The Investor Hour, love everything you guys do. I can’t wait to get The Terminal up and running, by the way.” That’s a new Stansberry product that we’re working on.
“Anyway, with respect to the Ferris rant about Peloton in episode number 118, I’d like to give some alternate perspective. I liked the rant, it cracked me up, but I think some perspective here might help.” He goes through and he agrees the valuation is probably off and the fluffy disclosures made him gag, but then he says, “As the owner of the Peloton bike and a consumer of Peloton online workouts through a monthly subscription, I do however think your understanding is flawed as it relates to the solution to a problem that Peloton provides. Let me explain.”
And then he basically tells me with a bunch of bullet points that he’s a busy guy, he’s 45, he’s married, it’s a two-income household, they’ve got three young kids. He’s a busy guy and so it’s better to be able to work out at home with the Peloton than to have to go to the gym. And then he says, “So what problem does the Peloton solve? What I just said.”
He says, “It solves the can’t get out of the house to work out every day because we’re a two-income family with kids. It provides an extremely time efficient way to knockout a pretty intense workout in 15 to 20 minutes or longer if you have time. I liken Peloton somewhat to what Apple did with iTunes like that Dr. Dre statement to Steve Jobs that, ‘Wow, someone finally got this right.’ It’s a really nice interface, easy to understand, and I use it as I need it.
One of the great side benefits is Peloton also has stretching, core strength workouts anywhere from 10 to 30 minutes that I can do in a hotel room ‘cause I travel quite a bit. It provides a structured way to track your workouts each month, and maybe most importantly does a good job of injecting competition energy expended into the group workouts. There’s some measure of community there for what it provides. Yes, I’d much rather go out running with a buddy, but remember I live in freezing Chicago winters.”
Then he goes on and makes a few more comments. “Best regards, Steve. B, Chicago, Illinois.”
OK, I’m not a fitness expert. I recognize that Peloton is a really nice piece of gear and that it does what they say it’ll do, absolutely. You pay your $2,000 and your $39 a month and you get all your stuff that you just told me about, and that’s valuable to some people. Part of my point was simply that if you want to, you can get in world-class shape without buying exercise equipment, without paying $2,000, certainly without paying $2,000.
So, you like it, yes, and lots of people like it. For $2,000 and $39 a month you better like it, right? And I get that, and I get the research about the short. You mentioned the intense workouts, then there’s research about this, but I know for a fact that you can craft an intense workout without paying a penny for exercise equipment. You certainly can. This human body that we have that responds to these things got that way before there was Peloton, before there was electricity in fact, and before there were gyms and anything else.
That’s my point, but you like your Peloton, I get it, lots of people do. I don’t have a moral opinion. It’s not immoral to purchase exercise equipment. I just don’t think it’s necessary. So, the next question I’ve got here is from Sheldon, I think it was from Sheldon S. I didn’t put that last initial like I always do. Sorry, Sheldon.
He says, “This wasn’t on Investor Hour, but thank you for your explanation of convertible bonds.” I threw that in a recent Digest in the past couple weeks. He continues, “I assume that since companies can sidestep ratings, the next big thing will be most/all bonds will be issued as convertible bonds. Does this mean that if the company’s stock price deteriorates over time the bond can be converted at a lower cost especially for _____ _____? If that is so, wouldn’t it be equivalent to negative great government bonds? Thanks for the enlightenment, Sheldon.”
No, they predetermine the price where it converts, but I think they can be flexible about it. They can put different terms in the agreement. I’m not specifically familiar with all of the different ways that you can structure a convertible bond. However, you did make this one comment where you assume since they can sidestep ratings, that the next big thing would be most all bonds issued would be convertible. I don’t think so.
I think this will always be a thing that you will do if you’re trying to get around the ratings because especially now, interest rates are super low, so man, if you can’t just issue regular debt for a super low interest rate, you got a problem and you need to do something alternative, and this is one of those alternatives.
I think it will be that way for at least as long as interest rates are super low, and it wouldn’t surprise me one bit if convertibles always remained this sort of alternative path because, look, if your stock price is way the heck up, you could issue equity. If it’s way the heck down, it’s a garbage proposition to issue equity, and then maybe you’re in one of these convertible situations, and maybe they can buy back the debt before it converts or something. There are different scenarios. I can’t begin to play out all the possible scenarios, but the point is I think it’s still true that this is an alternative for kind of crappier companies.
OK, next, Craig R. writes in with a very short e-mail, but I’m only going to read one line from Craig R.’s e-mail, and Craig R. said, “Peloton is too stupid to live.” Thank you, Craig. I don’t know about all that, but I appreciate the sentiment, brother. Thank you very much.
I got one last one here. “Hi, Dan. Love the podcast.” This is from Andy F. “Hi, Dan. Love the podcast. Tips for those thinking about shorting Peloton: buy a pair of Bluetooth headphones and listen to Dan’s podcast each week while you workout instead of listening to the spin instructor.” OK, maybe. That was number one and then he’s got number two. He said, “Regarding WeWork, you mentioned IWG, but listeners may not know that this is the corporate name for Regus” a big company.
He said, “I used Regus for a few years. They have good people working for them. Knowing they went bankrupt, it reinforces the challenges of this business model. They’re always fighting turnover” which is what I alluded to before when I was explaining the difference between CBRE and WeWork. He continues, “If there is any success on behalf of the tenant, the tenant is going to get the scale to want to get a more permanent space. If a tenant is unsuccessful, then they’re lost. They’re gone. Heads they lose, tails they lose.” That’s not a bad insight, actually.
He says, “Back to WeWork. My ten-person firm looked at getting some temporary space from them in case we needed a bridge. We were moving to a new lease. The cost was very expensive, high enough to want to look at other options. Their business model from what I could tell was beer, yes, beer. They sell you in a hip common area where you can get a beer. That was it. Very expensive modern spaces with beer.” So, you’re saying beer then, Andy?
Then he finishes up here, “Regus is cheaper with the savings. You can buy beer for the entire floor and store it the refrigerator provided by Regus. Best, Andy F.” Andy, thank you. That is a great way to end this episode.
I want to also throw out a special thanks to Angelo C. for writing in about Australian franking tax credits. I mentioned I didn’t know what they were and I hadn’t looked them up, and he wrote a nice e-mail to explain how it works, but you can just Google “Australian franking credits” and you’ll find something that will explain it all to you.
OK, that’s another episode of the Stansberry Investor Hour. It’s been my privilege and a lot of fun to come to you this week, and it is my privilege to come to you every week. It’s a great way to spend time with you, and thanks for listening. So, look, just go to our website www.investorhour.com.
You can get a transcript for every episode there, and you can listen to every episode we’ve ever done from the very beginning and get a transcript of every episode we’ve ever done from the very beginning, and you can put your e-mail in and sign up to get an alert for every episode we’ll do from now on, so it’s pretty cool. Investorhour.com. Thanks so much. I will talk to you next week. Bye-bye.
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