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Is WeWork’s Demise a Positive Sign for Value Investors? (w/ Whitney Tilson)


ED HARRISON: Whitney Tilson, it’s a pleasure
to talk to you. We’re going to talk a lot about value investing–
some of the ideas that you have. What you’re doing currently with Empire Financial
Research. But the first question that pops to me when
I look at your resume is that your parents were teachers. How is it that you got so involved in investing? WHITNEY TILSON: Yeah, well, it didn’t come
naturally. That’s for sure. My parents, their entire lives, never owned
a stock. So it wasn’t like investing or business was
ever talked about around the dinner table. I grew up in developing countries– Tanzania
and Nicaragua most of my childhood. My interest in business developed when I was
an undergraduate at Harvard and got involved with Harvard student agencies. And I remember, probably my sophomore year
as an undergrad, somehow through some friend, went sat in on a Harvard Business School class. And I just loved the case study method. And I still remember the case and what the
insights were. And I knew right then that I wanted to go
to Harvard Business School. And that was my mission from that point forward. So I did a bunch of entrepreneurial stuff. Coming out of college, I was employee number
2 helping Wendy Kopp start Teach for America, then did a fairly traditional 2-year associate
program at Boston Consulting Group and was lucky enough, knock on wood, to get into Harvard
Business School– the only school I applied to. If I hadn’t gotten in, I just would have waited
and applied to some other schools later, but got in, and off I went. But up until that point all the way through
Harvard Business School, had no interest in investing. I was very in business. So when The Wall Street Journal came, I’d
read it, except I’d take the C section, the Money and Investing Section, I threw it in
the trash– never even read it. So my only exposure really to investing was
through my college buddy, Bill Ackman, who was very interested in investing at a young
age. And I still remember bumping into him on campus
back on black October 1987. And he was white as a ghost. And I said Bill, what’s the matter? And he said, did you see what happened in
the stock market? I said no. And he’s like, well, it just had its worst
day since the Great Depression or something. And my family just lost millions of dollars. And I was thinking to myself, gee, I wish
I had millions of dollars to lose. But so Warren Buffett came to speak at Harvard
Business School when I was there. And I didn’t even go hear him– incredible
opportunity, because I didn’t even know who he was. So it wasn’t until the mid ’90s– I graduated
in 1994, so call it ’96 I’d say. I got interested in investing for a very simple
reason. I had $10,000 in my bank account. It was the first time in my life I ever had
any savings. I had college debt. Then I had business school debt. I had gotten married back in ’93. My wife was working as a lawyer. We were living in her grandparents’ apartment. So we had a low cost of living. Both of us had incomes. I was working in the nonprofit sector at the
time. So I didn’t have much of an income. But between the 2 of us, we finally had some
savings, paid off our debt, had $10,000. And so I called up Bill. And I said, Bill, what should I do with it? I want to invest this money. And keep in mind, 1996 or so, you’re now 14
years into this big bull market. Everybody’s talking about stocks. The early germs of the internet are sprouting. So Bill said, all you got to do– I still
remember his exact words. He said, all you have to do is read everything
Warren Buffett’s ever written, go back and read all his annual shareholder’s letters. And you can stop there. You don’t need to read anything else. That’s when I discovered Buffett, read his
shareholder letters. And that led me to a couple of years later,
start going to the Berkshire meetings. I read Roger Lowenstein’s book, Buffett the
Making of American Capitalists or the first major biography of him. Then that led me to The Intelligent Investor
to Peter Lynch’s books, Beating the Street, and One Up On the Street, Seth Klarman’s original
book, et cetera, et cetera. It led me into the literature. And I just got more and more into it and started
buying a few stocks here and there. And at the time, I’m embarrassed that I was
sort of speculating in penny stocks, hot tips somebody had given me. But fortunately, I least, fairly quickly started
gravitating toward higher quality businesses and Buffet’s influence. And Bill Ackman’s influence started to steer
me into higher quality businesses. And then I did that for a couple of years,
started managing. At this point, maybe my wife and I had saved,
I don’t know, $100,000. I put that money in an E-Trade account, started
buying the Gap, Dell, Microsoft. AOL was my big score– went up six times in
a year in the late ’90s. And I quickly came to believe that I was God’s
gift to investing, because every stock I picked went up. I now look back and realize I really wasn’t
doing much fundamental research, didn’t have any particular insights. I was just sort of buying what was hot. And it was a stock market not too dissimilar
to what we’ve seen over the past 10 years where you just sort of bought some popular
blue chip stocks. And they just went up every year. And you look like a genius, right? So it was at that point Bill was probably
4 or 5 years into his first hedge fund called Gotham Partners. He had grown it from $3 million at inception
to $500 million under management. He was hot. And I figured, well, if I’m as smart as Bill,
and if my friend can do it– Bill and I are very close friends. But we’re both super competitive. So sort of in late 1998, my non-profit job
after 5 years working with Michael Porter at Harvard Business School is something I
had started coming out of HBS was winding down. I said, why don’t I do what Bill did a few
years earlier and just hang out my shingle as the world’s smallest hedge fund? And so 6 weeks later, it was mid-November
1998. And I made that rash decision. I’ve been telling every young person ever
since, don’t try and do what I do, which is rush out and start a fund out of your bedroom
with $1 million under management with absolutely no experience, either on the business side
of running and building an investment management business or really on the investing side. I was sort of a late ’90s bull market genius. But that’s how it came to be. And I opened my doors as the world’s smallest
hedge fund on January 1 of 1999 with $1 million from my parents, my inlaws. Bill threw in a little bit of money. His dad threw in a little bit of money, plus
my own money. That got me to about $1 million dollars when
I started. ED HARRISON: But you say that you didn’t have
a lot of acumen. But you hit a lot of home runs. I mean, subsequently over the next 2 decades,
you did very well. WHITNEY TILSON: Yes. Well, I split it sort of into 2 periods. The first dozen years or so, I really did
knock the cover off the ball. It was a great time for investing. And to some extent, I was smart and lucky. But a lot of hustle led to the luck. What’s the old saying? The harder I work, the luckier I get. So as an example, only a year after I started,
we’re now in the spring of 2000. A year after I launched, I was up to about
$4 million. And I heard that investing legend Joel Greenblatt,
who I’d read his book, You Can Be a Stock Market Genius. Again, one of those classic early value investing
books, that he was teaching a class up at Columbia Business School. So I found out when the first class was and
in what classroom. And I just showed up. And I sort of looked like a student. I was only 5 years out of business school
myself. So I sat in the back of the classroom. And he didn’t notice me or anything. And I learned for the couple hours he was
teaching that day. And then I went up to him after class. And I introduced myself and confessed that
I wasn’t a student but that I was a big fan of his. I’d read his book. I’m watching my own little hedge fund. Would he mind if I sat in on the rest of the
semester? And he got a very uncomfortable look on his
face, because it’s against Columbia Business School policy to let just random right come
sit in on their classes. He said, I’m not supposed to do this. But if you promise to keep quiet– like, you
can’t participate in any of the discussions like a regular student. But if you just want to sit there and keep
quiet, I’ll look the other way. And so I did. And that was an incredible investing education,
because this was the absolute very peak of the internet bubble was March 10th of 2000. I was taking his class that week. And he was preaching the gospel of special
situations. And it’s hard for young people today who didn’t
live through it to understand anything that wasn’t nifty 50 internet-related, then, was
incredibly cheap. Good industrial kind of businesses trading
at 3 or 4 times earnings. Berkshire Hathaway had fallen from $70,000
a share down to just over $40,000 a share, which was sort of cash and investment. So you got a much younger Buffett and Munger
75 operating businesses for free. He was trading a cash and investments. So that was an opportunity that I put 30%
of my little $4 million fund into Berkshire Hathaway. I got lucky on the timing. I’d been buying it. I’d owned it since I started my fund a year
earlier. I bought a little more on the way down. So I wasn’t perfect on the timing. But the day I really backed up the truck on
it happened to be just coincidentally the final day of the NASDAQ blowoff to the upside
and not coincidentally, because money was coming out of value stocks to go into astroturf.com
or whatever and was the day Berkshire bottomed. Within 2 months, Berkshire was up 50%. And that was a 30% position for me. So that’s a combination of sort of being lucky
but also being good and having some courage and being willing to take a big bet early
in my career, because one of the things I tell young people who are trying to bootstrap
a fund like I was is, you have to look for a couple opportunities to take some risk to
deliver some outsized returns, because otherwise, you’re going to be stuck in the small fund
trap. The vast majority of funds that start with
$1 million out of their bedroom like I did– the vast majority never even get to $10 million. And that’s just not a viable business. So I got lucky in that the market offered
me an opportunity to put 30% of my fund into something that was both super safe and super
cheap. The dilemma today is, you can take a big bet
and put 30% of your fund into Bitcoin or something. But chances are you’re going to get clobbered. So there was some luck there early in my career. So I made the pivot away from being sort of
a nifty 50 big cap popular momentum stock investor into small cap value stuff, very
obscure little businesses, universal stainless steel, a little company called Aon. I can’t even remember– Imperial Parking–
these obscure little companies that were super cheap and beaten down. And I could see big picture, the large cap
growth was trading at a valuation premium relative to small cap value. Just the sectors were trading at– I don’t
know– 20 or 30-year gap in terms of valuation. And so I had ridden the big cap, large cap
growth stocks for a few years mostly out of ignorance, not because I sort of said, hey,
I know these are really overvalued, but momentum is momentum. And I’m just going to ride it. Even that I would’ve had some respect for. I didn’t even have the good sense to do that. But it was a very deliberate decision over
the course of roughly 2000 and 2001 is, is, I got Warren Buffett value investing religion. And I thank Bill Ackman and Joel Greenblatt
and some other real value investors who helped teach me. And it was in the nick of time. And so I got into the cheapest, most beaten
down sector at the right time. So as the internet bubble burst, and the market
was crapping out in 2000, 2001 into 2002, I was in a sector that did pretty well. So I started putting up pretty good numbers. I was beating the market every year. And I picked up a writing gig at the Motley
Fool. And that website had a lot of traffic and
was riding the AOL Iomega internet bubble. And then when that burst, there was basically
nobody over there that had much credibility, because they had been giving advice that incinerated
all of their readers. And then there was me. And I’d been pounding the table for over the
course of dozens of articles. I was writing, at least, 1 article a week–
sometimes 2 or 3 a week and with a pretty consistent message– listen to Warren Buffett,
buy Berkshire Hathaway. The internet is a bubble, get out of these
overvalued tech stocks. One of my favorite articles back then was
called Cisco, Apple, and Probabilities. It’s still on the internet today. Just google Whitney Tilson’s Cisco, Apple,
and Probabilities. And basically, Cisco was the market darling
at that time for a while anyway– had the biggest market cap in the world. To this day, 20 years later, still a great
company. The stock has not reached the peak that it
hit 20 years ago. And meanwhile, Apple– and this is after Steve
Jobs had come back in sitting on a big pile of cash, basically not losing money but wasn’t
making any money yet. But you had Steve Jobs and the Apple brand,
a lot of loyal customers, and a big pile of cash. So you had a clean balance sheet. Apple was trading– if I recall, it had something
like a $3 billion enterprise value– $3 billion for a company today that’s about $1 trillion,
right? And I said, I’m not arguing that Apple is
as good a company as Cisco. What I’m arguing is, is that Apple the stock
at three times earnings is a better buy than Cisco stock at 150 times earnings. So that was the kind of message out there. So as the internet bubble burst, the Motley
Fool promoted me to 1 of their highest profile writing positions called Fool on the Hill. So I was the Fool on the Hill every week. And so that really got my name out there and
helped me build my business combined with the good numbers I was putting up. So my fund grew and grew. And basically for the next 10 years or so
up through the housing crisis and all, I was consistently beating the margin. I think 10 of my first 12 market, I should
say– 10 of the first 12 years I was ahead of the S&P. Money was coming in. I nailed the internet bubble. I later nailed the housing bubble– ended
up on 60 Minutes. It was a piece on the housing crisis that
ended up winning an Emmy. And I was sort of the featured guy who predicted
it. There’s few things that are better publicity
than being on 60 Minutes when they’re trying to make you look smart. You don’t want to be on 60 Minutes’ bad side. So know that got me up to about $200 million
under management. At my peak, I brought in a partner a few years
earlier. And the 2 of us were sort of off to the races
and $1 billion under management. And having retirement money for ourselves
was sort of next in line. And then the wheels fell off the bus. And over the next couple from middle of 2010
through 2012, the next 2 years, we were down 25% in a plus-50 market. And it was due to a bunch of different factors. But– ED HARRISON: So in hindsight, what factors
would you look at as the most important factors? WHITNEY TILSON: Yeah, well, any great train
wreck generally has what Charlie Munger calls Lollapalooza effects. In other words, it wasn’t just 1 thing. It’s a whole series of things. Our portfolio in terms of the partnership
I had, we didn’t have clear lines of responsibility. And there was no tie-breaking mechanism. So 1 areas, our portfolio became very bloated. He had all of his favorite stocks. I had all of my favorite stocks. So we were wildly diversified. But then, almost counterintuitively, we were
overly concentrated in some of our favorite positions. And a couple of them– some iridium warrants–
we got sucked into the Ron Johnson JC Penney story. So we had a couple bad stocks. But it wasn’t fundamentally bad stock picking. But 1 lesson I certainly learned is, is that
I did not fully appreciate early in my career is the importance of portfolio management,
as opposed to stock picking. I always just thought, look, if you pick good
stocks, you’re going to do great– full stop. And for my first 5 or 10 years or so, that
was generally true, because all I did was own a dozen stocks and didn’t have any short
positions. And so that was it. What I realized, though, is, is sort of as
we got smarter, we started short selling. We started buying options and warrants. Our prime broker was very happy to have us
go out on margin. So we started levering up with our favorite
positions. And we started to trade around our positions
more. So the combination of all of those being more
aggressive in all of these areas of portfolio management, initially, all of those things
I just mentioned worked. And so that sucked us into doing more of them. But very slowly over time, we ended up having
a very risky volatile portfolio that was extended out on margin and had a lot of options and
had a bunch of risky securities, like a JC Penney turnaround and iridium warrants and
so forth, that caused our portfolio to start swinging around like crazy and ultimately
led to some real train wrecks in some of our positions. And so we ended up 2011 really was our Waterloo. We’re down 20% in a plus-2 market if I recall. And we never really recovered from that. In 2012, my partner and I decided, we were
better managing money as individuals than we were together if you look at our 8-year
track record together. And we had some disagreements over how to
fix things, because we just put up a negative 20- year an a plus market, right? And so we just decided to separate the fund. And so I relaunched on January 1 of 2013. And I took everything to cash and slowly started
to rebuild the fund. And so the last 6 years or so– 5 years–
I guess– when I was running the fund on my own– maybe it was because I was so scarred
by what had happened the previous couple years– my fund was way too conservative. So keep in mind we were now 3 or 4 years into
this 10-year bull market. And I had gotten accustomed to buying stocks
really cheap when there was blood in the streets in ’08 and ’09. And so there was the European debt crisis
and so many other things that I thought could lead to a real pullback in the market. So I was playing value investing defensive
investing. So I had a bunch of cash. I rebuilt my short book. And I was sort of underexposed on the long
side, waiting for those cheap opportunities to come. And they never came. I completely misread this bull market. And I ended up trailing the market year after
year. So it was no longer the big losses that had
broken up my partnership. It was just fatigue. It was drip torture. It was most of my investors were individual
investors who had their money in the S&P 500 index. And here I was charging hedge fund fees and
underperforming that index. And it was sort of hard to justify. And so money leaked out. And my assets eventually trickled down to
about $50 million, which a lot of people would kill for a $50 million fund. That’s actually not a bad business with the
right cost structure. But I just felt like I’d lost my mojo. I was fatigued. I felt like I was letting my investors down. And so I eventually said, you know what–
I got to hit the restart button here. And so I returned my investor’s capital just
about 2 years ago at the end of 2017– September 2017. ED HARRISON: Well, as you tell that story
that the first thing that pops out to me is your realization that in terms of the Warren
Buffett value investing mentality that you had it reversed in terms of where you were
concentrating your efforts. You could concentrate your efforts on cheap
stocks or ones that have moats. But you were concentrating your efforts on
the cheap stock area. And in retrospect, do you think that that’s
the wrong– tell me about that. WHITNEY TILSON: Yeah. Well, look, one of the things I did after
I closed my fund is, as I sat down, and I looked back through my entire 20-year history,
read all my monthly investor letters and looked at my portfolio where I’d made and lost money–
and I realized that I had owned some of the greatest stocks of all time. I owned Apple back when it would had a $3
billion market cap. I owned Netflix in 2011 and ’12 at a $3 billion
market cap. That’s been about a 50 bagger. Apple’s been a 300 bagger. I owned Ross Stores at a $1.70. That’s been a 70 bagger. The only one that I really identified a quality
business and just hung with it was Berkshire Hathaway, which I owned from day 1 to year
18 when I closed my fund. I owned it consistently. But the rest– I bought them. I owned McDonald’s back when it got really
cheap in 2002, early 2003– got down to $12 a share. What’s it at? $200 today. I owned Home Depot. You name it. Yet, I had sort of owned them at the right
time. When great companies had encountered what
turned out to be temporary difficulties, their stocks got cheap– I bought them. That part I did quite well. The problem is, is the stocks then went up
50%. And they didn’t appear as cheap anymore. And I sold them. I realized– probably my single biggest mistake
over 20 years is that I probably paid– there are 2 main things you’re looking at, which
is price, valuation, and business quality. And I was smart enough to understand they
were both important. But when I look back, and I look back at my
decision-making, and where I was screening for stocks, I was probably 75% focused on
statistically cheap stocks– low price-to-earnings, price-to-book, cash flow, whatever traditional
valuation multiples. And I was only 25% focused on business quality. So when I went out to look for businesses,
I would screen for statistical cheapness. And then I’d come up with, let’s say, 100
companies. And then I would look for the better businesses
among them. And what I should have done is the exact opposite,
which is, I should have said, let me go out and find the 100 greatest businesses that
grace the planet Earth and that have the biggest moats that have the brightest futures that
have the most long-term potential. And then let’s look there for the ones that
are being temporarily mispriced when I can get in at a good price. But then once I’m lucky enough to get in at
a good price, I’m going to ride them until the story changes. Stories sometimes change. Valeant was a 20 bagger before the story changed
and went down by 97%. I’m not saying my mistake was I never should
have sold anything. If you make a mistake, the story changes. Or if the valuation truly gets extreme, you
need to get out of a position or, at least, trim it. Obviously part of a critical part of portfolio
management is position sizing and managing a high-class problem, which is, you put on
a 5% position in a stock. And then it doubles. And it doubles again– it doubles again. It’s a high-class problem. But figuring out when to let your winners
run– how much and when you trim, et cetera, is a key part of that. So that was a big mistake. I’ve still consider myself a value investor. But I sort of say, I’m not a value investor
or a growth investor. I’m make money investor. I’m much more open today to paying up for
a stock that may not look cheap on a current year’s earnings multiple or something like
that but where I can think, OK, 5 years from now, where do I think this company is likely
to be? And what can it be earning 5 years from now? Whereas historically, I was only willing to
look at current year earnings or maybe what they were earning next year. I wasn’t willing to look out any further than
that. So I missed a lot of the great moon shots. Another stock, by the way, I owned back in
1999 was Amazon, for goodness sakes. Right? ED HARRISON: We should talk about that, because
I think that it was Doug Kass I saw on your site who was talking about Amazon. But the first thing that came to mind when
you were telling that story was the European banking sector, because we’ve been talking
about European banks. Actually, I spoke to an investor last week
or the week before last. And he said in his fund, he has no European
bank stocks. Yet when you look at them on a price-tobook
valuation, Deutsche Bank, for instance, is trading at 20% of book, 30% of book. I mean, that’s a cheap stock. When you look at it from the paradigm that
you’re talking about now, how do you look at the banking sector as an example– financials
in general? WHITNEY TILSON: Well, generally, banks, particularly
investment banks which are big derivative books, cause I think you have to differentiate
between just your standard retail banking franchises versus investment banks, like a
Deutsche Bank or something. Generally speaking, they make me nervous. Insurance companies I’d throw in there, as
well, in that there’s black swan risk out there, because there’s leverage and because
they have big, either derivative books or loan books where it’s very difficult often. They’re sort of black boxes so you know what’s
in there. So you just have to have a lot of confidence
in management, generally, which is why Berkshire Hathaway, certainly, is something I felt comfortable
owning just because I’ve studied Buffett and Munger so closely and understand their fundamental
conservatism. But there aren’t very many other financials. I mean, the financial sector, the history
of financials is just littered with boom and busts and management teams that are out there
trying to deliver steady earnings growth in a sector that often doesn’t lend itself to
that. My general view of the European financial
sector is, is after the great financial crisis in ’08 and ’09, the US did a very good job
of forcing the entire financial sector to clean up to realize their losses, to run off
their bad banks, and to clean up underwriting standards, et cetera, but mostly to take their
medicine. And we cleaned up and recapitalized, et cetera. And that didn’t really happen in Europe. I hosted an investment conference in Italy
every summer. And so I’m talking to my Italian value investor
friends over there. And the Banco Monte dei Paschi. The oldest bank in the world, a dozen years
later is still on death’s door and has had to do multiple rounds of capital raising,
because they sort of had a bad loan book but didn’t or couldn’t take their medicine. There are a lot of things– I’d say the vast
majority of what I look at generally just goes into the too hard bucket. ED HARRISON: So Deutsche Bank doesn’t interest
you, because– and by comparison, I think that when we were talking, I thought it was
interesting. When you do the 25, 75– 25% cheap, 75% good
business, it brings us immediately to the GSEs. Oh, so when you talk about financials, the
juxtaposition between the black box of the investment bank versus what I would consider
a dominant position of the GSEs is very interesting. And that’s a very interesting political story
that I think that you have a lot of knowledge about. Tell me I’m little bit about what’s going
on there. WHITNEY TILSON: Yeah, well, it’s interesting. Since I started my investment newsletter in
April of this year, I’d say at least half of the half dozen or so recommendations we’ve
made so far, I have a free daily e-letter that goes out to 35,000 people or so every
day. But once a month, we put together a 10 to
15-page report on our single best investment idea. And that goes to our paid subscribers. So once a month since March, we’ve had a half
dozen ideas. The majority of them have been ideas from
back at my hedge fund days– companies that I’ve known for a long time. And one of the more interesting speculations
that was in my hedge fund was Fannie and Freddie, the government sponsored entities, the mortgage
giants, the GSEs, which, in many ways, what happened to them is exactly what happened
with AIG, for example. They were correctly– both AIG and the GSEs
were deemed systemically important. The US government came in, gave them an unlimited
line of credit to make sure they could get through the crisis and all, and took 80% of
their stocks. And that’s what happened in ’08 within a couple
of weeks of each other to both the GSEs and AIG. What happened with AIG– let’s start there,
and I’ll tell you what happened differently at the GSEs. In the case of AIG, the company recovered. As the economy and financial system recovered,
AIG sold off assets, returned to profitability. They paid back the government loans with interest. And then the government still owned 80% of
the stock, which the government over the course of a number of equity offerings exited the
position. And the government made a fortune of AIG. And AIG is now an independent privatized and
very carefully regulated major financial institution today. That’s exactly what should have happened to
the GSEs. The problem is, is in 2012, just as the GSEs
we’re about to return to massive profitability– they’re incredible franchises. They control about 50% of the mortgages in
the world’s largest debt market. These 2 entities have 50% market share. And they just mint money, because their government
backstop. They can access capital at ultra low rates
and make a very nice spread. And after the financial crisis, all their
competitors have gone bankrupt. The guarantee fees had tripled. So they were about to end their losses started
to diminish, such that they were about to start minting money. And then in 2012, the government just decided,
you know what– we don’t like that. We don’t like the fact that you’re going to
make a lot of money and that shareholders are about to get rich. And so they just arbitrarily changed the terms
of the conservatorship, the bailout deal– ED HARRISON: But didn’t they realize at that–
WHITNEY TILSON: –and they did something called the net worth sweep, which was to take all
their profits forever. ED HARRISON: Now, the sweep was precipitated
by a realization that, in fact, that this was going to occur that they were going to
go– WHITNEY TILSON: Return to a high degree of profitability. And ironically enough, though, the government
has been defending the sweep for saying precisely the opposite, which is that we were worried
about stabilizing the housing market and the soundness of the GSEs. But subsequent discovery and testimony in
the court cases has revealed that that’s a 100% lie contrary to the facts where emails
we’re going back and forth where the CFO of one of the GSEs was emailing the regulator,
saying, yeah, by the way, we’re about to start earning a ton of money. And so it was, I think, a political action
where the GSEs– even remember, the controversy over AIG and how angry politicians and the
general public were about this big giant that behaved badly that was getting bailed out. And now shareholders are getting rich and
so forth. Well, the GSEs, that was AIG times 10. And so I think the Obama administration sort
of felt like for political reasons, that they didn’t want that to happen here. They feared a political blowback. So they engineered a blatantly illegal seizure
of private assets. In other words, shareholders had bought the
shares of the GSEs based on the terms of the bailout in 2008. And then the government just said, no, we’re
going to take all the profits forever. ED HARRISON: At some point in time, people
thought maybe Fannie and Freddie should be public. I mean, the reason that they exist is for
public benefit. WHITNEY TILSON: Correct. ED HARRISON: So you could make the argument
that the reason that they were doing that is because there’s an argument to be made
that, at least for the foreseeable future, given how irresponsibly they behaved in the
past, we’re going to make these governments, not just sponsored, but government enterprises. WHITNEY TILSON: Yes. Well, look, the government back in 2008 had
2 choices– conservatorship or receivership. Receivership would have involved just taking
them over completely, having them become part of the government and probably a wind down,
although it turns out they’re sort of irreplaceable. But had they gone into receivership, the shares
would have been canceled. And that all would have been fine. That would’ve been an option. Now, the government didn’t go that route,
because it did not want to bring a $5 trillion loan book onto its own balance sheet. OK? So instead, the law says, OK, if you pick
conservatorship, that’s all well and good. But according to the law that guides either
receivership or conservatorship, conservatorship– think about what the word conservatorship
means. It means you are conserving them. You are supposed to be recapitalizing them,
et cetera. So the government said, OK, we don’t want
$5 trillion on our balance sheet. So we’re going to go the conservatorship route. Well, that’s all well and good. But then the net worth sweep, which is take
away all their profits forever so that they can never rebuild capital, is the complete
opposite of what the law says conservatorship is all about. So to make a long story short, what’s interesting
is, as we sit here today, is this is the first day of trading on a Monday after last Friday
when the Fifth Circuit Court of Appeals after years and years of litigation where mostly
some big deep pocketed hedge funds, very unsympathetic plaintiffs, have been suing to overturn the
net worth sweep. They finally won. And a court of appeals Friday after the close
ruled that the net worth sweep was illegal, remanded it back to the lower court to then
decide what to do about it. And Secretary of the Treasury Mnuchin just
this morning said, even before the lower court redecides this case based on the Court of
Appeals ruling that the net worth sweep is illegal that we’re going to stop the net worth
sweep administratively in the very near future and all. The last I looked, the stocks were up 21%
today. And honestly, we put out a special alert to
our subscribers this morning, saying, the market is underreacting. The stocks should be up 50% or more today
based on this legal ruling, because now the net worth sweep is gone. And shareholders now own 20% of 2 of the world’s
most valuable and profitable businesses. They combined– earned $20 billion last year
in profit that was all swept away by the government that now both the court and Treasury Secretary
Mnuchin just said, that money is now going to accrue to the GSEs. And keep in mind, this is a huge win for the
taxpayers, because the government owns 80% of the GSEs. So shareholders are winning alongside taxpayers. And very importantly, one of the key things
that has to happen here is, is because the GSEs have not been able to retain any of their
capital, they’ve sent $301 billion to the government over the course of this net worth
sweep in the last 7 years. That is capital that should have been accruing
to the GSEs to allow them to rebuild their capital basis. They need to get up to, I guess, $150 to $200
billion of capital to be safely recapitalized. And so now that can start to happen. But that’s only happening at a $20 billion
year pace. ED HARRISON: Let me interrupt you for a second
there. There are a number of different thoughts on
this. One is, first and foremost, I think, is Mnuchin
and the Trump administration’s plans for the GSEs going forward in terms of the recapitalization,
because it’s been clear from the beginning. I spoke to David Metzner of ACG Analytics
about this that Trump wants them to be private, has reprivatized, taken out of conservatorship
in which case they need to be recapitalized. So what has Mnuchin said? What’s the timeline for that happening? WHITNEY TILSON: Well, he hasn’t laid out a
specific timeline for the whole process. It will probably take a few years before they
are truly independent. And by the way, a few years after that before
the government sells off, it’s 80% stake, just like it did with AIG. I mean, the irony here is, is we didn’t need
to reinvent the wheel here. All we needed to do is do with the GSEs what
the government did with AIG very successfully, which is declare victory, get paid back with
interest, and then sell off the stock and make another $100 billion in profits or something
in this case. So that’s the model. It will probably take a few years. It will eventually need some kind of congressional
action. But it’s the Trump administration and Mnuchin
and Mark Calabria, who heads up the Federal Housing Finance Agency, which is the GSE’s
regulator. Calabria and Mnuchin have both made it clear
that they are willing and able to act administratively. So that was what Mnuchin said just this morning
that they’re going to stop the net worth sweep immediately. ED HARRISON: So that means the recapitalization
is beginning. WHITNEY TILSON: That will be $20 billion of
capital right there each year going forward. Now, they will likely also need to do 1 or
more equity offerings to rebuild capital. And that’s another reason why treasury wants
their share prices to go up– why we think there’s a great opportunity in the stock right
now, because treasury and Mnuchin have 2 very strong reasons to want a higher stock price. One that they are representing taxpayers who
own 80% of the stock. So that benefits taxpayers for sure. But secondly, you can’t release them until
you recapitalize them. You can’t end the conservatorship. And to recapitalize them, you’re going to
need do some equity offerings, i.e., you need a higher share price. If the government takes actions that harm
current shareholders, good luck going out and trying to raise equity capital from new
shareholders when you just screw the old ones, right? That’s just not going to fly. In fact, exactly the opposite is true, which
is take actions that lead to a share price doubling to $6 a share, let’s say, and then
do a $20 billion offering. And then things are progressing nicely. And stocks now at $10 a share. Now, you do another $20 billion offering. You do a few of those over a couple of years,
plus the retained earnings of the companies at $20 billion a year. You probably convert the preferred stock. There’s a debate over at par or maybe some
small discount to par. The preferreds are trading about $0.50 on
the dollar today. So that’s a good investment as well. All my fellow bulls on the GSEs– we agree
on a lot of things. But everybody seems to disagree on whether
the best way to play it is the stock versus the prefs. Generally speaking, the prefs are senior in
the capital structure. And there seems to be a fairly clear path
to you getting par or close to par there, in which case, you double your money. ED HARRISON: So they’re trading below par
right now. WHITNEY TILSON: They’re trading about 50%. There are many, many different series and
depending on liquidity and exact terms but call it $0.50 on the dollar, whereas, the
common has more risk. But I think you have multi-bagger upside in
the common. So there is a scenario, by the way. The prefs would argue that in order to rebuild
capital, they’re going to have to convert us at par. So we’re going to double our money, whereas,
there could be massive and multiple dilutive share offerings that dilute the common and
keep the common share price depressed. Witness European banks, for example. But so we prefs. I’d much rather on the prefs, because I have
a very high probability of doubling my money. But I understand I’m not going to make more
than that. And I avoid the risk of dilution and a long-term
depressed share price if I just owned the common. And I agree that that’s a conservative way
to play it. My argument and my recommendation to my subscribers
is, is make it a smaller position. Maybe make it a 3% position, whereas, I might
have a 5% position in the prefs. A little bit smaller position in the common. It’s riskier. But I think you’re compensated for that risk
by– the long-term upside here depends on a lot of different factors. But it’s not just a doubling. You could have a 5 or 10 bagger on your hands
over time. And I’m, as a shareholder, I generally look
to invest if you pull back to– you recall what I said about, what do I really look for
is, is insanely great businesses with impregnable moats that are minting money where I can buy
their stocks that are temporarily depressed due to factors that are either fixable or
will somehow go away over time. And then I want to ride them for 10 or 20
years to 10 or 10 bagger or more returns, right? That’s what I get with the common stocks here. But quite speculative. There are plenty of scenarios, even after
the nice legal victory on Friday where you could have a permanent impairment of capital. And that’s why I’m saying, normally when I’m
recommending stock ideas, it’s not worth doing if you don’t make it a 5% position at least,
right? It’s hard to come up with good investment
ideas. Generally, you want to concentrate in high
quality businesses and establish good-size positions. This one I’m suggesting– it was a 1 and 1/2%
position when I recommended it last week. And then I said this morning double it to
3%. But that’s still small in light of this court
ruling, which I think has dramatically reduced the chance of a 0 or a real loss of capital
on the common stock side and significantly boosted the upside. The odds shifted dramatically after the court
ruling on Friday. And that’s why I think the stock is really
underreacting today only up 20% or so. ED HARRISON: So one of the big questions I
have, and I think that a lot of people have with regard to the GSEs when we think about
it is what led them to where they are now. And how much capital they need to protect
against that. One argument is that 150 to 200 might not
be enough, because they were undercapitalized relative to the risk that they were taking
right back in ’06, ’07. What’s your view on that? WHITNEY TILSON: Sure. Well, a couple of things. One is, is there is always going to be a government
backstop. There always was. But there was this big kabuki theater where
it was an implicit, right? It was never explicit. And the GSEs didn’t pay for it. But it was there when– ED HARRISON: We saw
that. It was there. WHITNEY TILSON: –we saw that in 2008. The government came in and backstopped it
all, right? And so the government is correctly recognizing,
now, but look, we just need to make it explicit. And we should charge them for it. And that’s fine. So think of it like a health insurance policy
where you cover everything day to day. But then anything above 100,000 or $1 million
or something, you buy tail risk insurance, right? That’s effectively what they’ll be doing. So number 1 is, is that tail will always be
there. But it’s very important that the GSEs are
capitalized sufficiently such that they never have to exercise that tail insurance. That’s what taxpayers and regulators should
demand. So the question is, is how much capital is
necessary? They’ve got a $5 trillion loan book today. And it is, by and large, a very safe and secure
loan book. The underwriting standards have been excellent
for the last 10 years. The kind of fraud that was taking place back
in the housing bubble days is virtually nonexistent. I tried to refinance my mortgage, and I’m
a pretty good credit. And they put me through. They gave root canal. And I’m thinking, wow, if they’re giving me
a root canal with a perfect credit history and so forth, that really speaks to the soundness
of the fundamental underwriting in the system. ED HARRISON: And what about the Alt-A and
the– WHITNEY TILSON: Yeah, and then there were 2 things. If you look at what sank the GSEs during the
credit crisis, and why they ran out of capital– or they didn’t really run out of capital. People feared that they would– is, it was
not their traditional conforming– mortgage book that they had guaranteed. It was that they had done 2 things really
going out the risk curve right at near the peak of the bubble, as they were losing share
to all the AmeriQuest and Countrywides of the world and WaMu’s writing bad loans and
then packaging them through the Wall Street, the private securitization machine that had
grown up during the housing bubble, Fannie and Freddie started taking Alt-A and subprime
mortgages, which they had never done traditionally. And I think at the very peak, it was 13% of
their loan book and accounted for 48% of their losses. So that was huge mistake number 1 that sunk
them. And then number 2 is, is they were engaging
in fixed income arbitrage. Effectively, they were becoming like gigantic
hedge funds and we’re out there just speculating, using their ultra-low cost of capital. I mean, imagine, boy, I would love to run
a hedge fund that could access capital at the US government’s rate, which is effectively
what they had due to their implicit government guarantee. So they took huge losses on their fixed income
arbitrage, basically hedge fund speculation business. So those, the Alt-A and the subprime and the
fixed income arbitrage businesses have shrunk or are basically nonexistent. So I think any part of releasing them, recapitalizing
and releasing is, is there will have to be very tight regulations that restrict those
kind of speculative activities so those kind of risks and leverage and so forth don’t build
up. If you do those 2 things, you should never
have to use the government’s tail risk. I think if you have somewhere between $150
and $200 billion of first loss equity capital underlying sound, well-underwritten $5 trillion
loan book between the 2 of them. ED HARRISON: That sounds interesting. Now, let me take a little transition here
for a second in terms of other things that are happening in today’s market. Something that’s on my mind is WeWork. And one of the reasons that it’s on my mind
is because when we were talking before, you were talking about McDonald’s being one of
your big plays. And one of the underappreciated things about
McDonald’s was their real estate valuation. WeWork is also a real estate company in many
ways. But there’s a lot of angst about what are
they really worth? What’s your view as a value investor on that? WHITNEY TILSON: I think WeWork is worth 0
and will be bankrupt within a year is my latest thought based on what I read over the weekend. The company is, roughly speaking, in the last
12 months, has $1.6 billion in revenue and $3.2 billion in costs. Thus, they lose about $1.6 billion, so they’re
hemorrhaging money. Now, there are plenty of businesses that have
lost a lot of money in their early stages that go on to be enormously valuable. ED HARRISON: And we’re talk about Amazon hopefully. WHITNEY TILSON: Amazon is one. But look at all the software service companies. Pharmaceutical companies– some of them require
years of investment and losses. But then you reach a critical mass or so forth. And you have a great business. The problem I have with WeWork, is I think
their entire business model, which is leasing long-term real estate. And by the way, at peak-of-the-market prices,
the real estate market’s been pretty strong in the US and elsewhere where they’re leasing. So they’re either purchasing or leasing long. And then they’re just doing month-to-month
leases to their clients. And they’re trying to wrap this up in this
big techno bubble and change the world and all. It’s just absolute nonsense. They’re just a real estate company that’s
borrowing long and lending short, essentially. And you know what happens to banks that do
that. It works great for a while until the market
changes. And the problem is, is what happens in the
next economic downturn? And there will be one– hard to know when. And I don’t have any strong feelings about
when. But all of their clients are on month-to-month
contracts. And so in a recession when people shut their
businesses or move them out of into lower cost space or whatever, we work still on the
hook for the mortgage payments on the real estate that they bought or the lease payments
on the real estate they leased. So I don’t think it’s the worst business model
I’ve ever seen. But it’s definitely in the bottom 25% as business
models go. And then, of course, they’ve let costs get
completely out of control. I don’t know if you’ve ever been into WeWork’s
space, but it’s all very architecturally fancy– fancy lighting. They spend huge amounts of money. And it’s a great deal for clients, because
investors are subsidizing $1.6 billion in losses, which is resulting in low-priced space
where you don’t have to sign a long-term lease. And they give you free drinks and beer and
beautifully built out space. And then you just throw in just a horrible
corporate governance and every other red flag you could– ED HARRISON: From the S1, we found
out a lot of– WHITNEY TILSON: Exactly. And every day, we’re learning more and more
bits of dirt on corporate governance and flaws and so forth. So you combine a business losing huge amounts
of money with a business model even at scale that is, at best, has mediocre profitability,
very capitalintensive, very competitive business, et cetera, combined with every corporate governance
and Silicon Valley nonsense red flag. And then they have these dreams of an absurd
valuation. And I don’t think the IPO gets done. And I’ve said that now for a number of weeks. ED HARRISON: And if the IPO doesn’t get done,
given that they’re burning all that cash– WHITNEY TILSON: I think they run out of money. I mean, what is bankruptcy when a business
runs out of money? And the private markets have been very kind
to unicorns, these money-losing private companies– take Uber, Lyft, and so forth. But, at least, I’m open to the idea that Uber
or Lyft could be very profitable businesses long-term. I don’t think it’s likely, but I think it’s
possible. It’s hard for me to see how it’s possible
for WeWork. And I think investors are seeing that as well. So the question is, is there was an article
over the weekend how SoftBank, which has been the primary financial backer of WeWork, is
going to take a big haircut. Even if they get the IPO done at $20 billion,
the last round was done at $47 billion. So SoftBank’s going to take a big haircut. If the IPO doesn’t get done, I think SoftBank
just woke up to, holy cow, our single biggest investment here is, even in a good scenario
is going to be a huge write down. I think they’re going to be reluctant to put
more money in. And if SoftBank isn’t going to, who else is
going to? And so I think WeWork could rapidly just run
out of money. And there’s no way you can cut your expenses
when you’ve got a cost or such a revenue cost mismatch. I mean, there were plenty of internet companies
back in 1999, 2000, where when the market fell apart, companies, like Amazon, like Priceline,
were able to cut their costs very rapidly and sort of limp along, at least, on a cash
flow neutral basis living off the cash that they had raised during the bubble days. And some of those stocks became 100 baggers
or more, right? I don’t think WeWork has that possibility. They’re not sitting on a huge pile of cash. And there’s no way for them to get that burn
rate down quickly or to any material degree, I think. I’d give better than 50/50 chance of a bankruptcy
in the next year or 2. ED HARRISON: Well, you mentioned Amazon. And we mentioned Amazon back and forth 2 or
3 times in this conversation. They were the 100 bagger. Doug Kass is talking about them as a buy. Why do you think that Amazon at this price
actually is a value investment? WHITNEY TILSON: There are a couple of different
ways to look at it. Generally speaking, I think Amazon in the
next 2 to 3 years becomes just a P/E multiple, earnings per share. You’ve always, historically for the last 20
years– and the reason I could never really get comfortable owning it is, is you sort
of had to value it on some– I don’t know– multiple of revenue or something many years
out. Whereas now, Amazon has just gone through
almost like a 10-year period of very heavy investment, particularly building distribution
centers to a much lesser extent buying content for their prime streaming service and all. Amazon, if you look back 10 years or so, sort
of had a 5% or 6% operating margin on their retail business. And then as they expensed building out a couple
100 distribution centers, et cetera, that went down to 1% or 2%, right? But that big expense is now ending. And the combination of retail profit margins
going back to 5% or 6%, which is not at all an unrealistic vision, given their scale and
dominance. And what they did historically combined with
Amazon Web Services is just an incredible business. ED HARRISON: What are the operating margins
there? WHITNEY TILSON: I don’t know– 40% or something
and growing at a super high rate. I don’t think anybody catches them. You combine those 2 things, and I think you
see over the next couple of years of profitability and Amazon just hockey sticking. So if you take $80 a share, I think that’s
a number 3 years out 2 to 3 years from now. Today stocks call it a 2,000 So that’s 24
times. Amazon, a 24 P/E business a couple of years
from now, Amazon is going to trade 24 times earnings. It’s going to trade higher than that. Amazon is just a juggernaut. I don’t see what can stop them from being
one of the most profitable businesses on earth. And it’s sort of ironic, because Amazon, you
would think inherently just sort of has a low margin business, just being the Walmart
of the internet, right? But distribution centers are much more efficient
than running bricks and mortar stores. And then you throw in Amazon Web Services. And then there’s a whole another element where
you or your viewers– just go to Amazon and just do a search for a big screen TV and see
what pops up. And what you’ll see is the first bunch of
links are all ads. And so Amazon is now becoming a third real
player in the advertising business behind Google and Facebook. Amazon’s much smaller but growing much faster. And keep in mind, this is just pure profit. And think about if someone searches big screen
TV on Google, how much is a big screen TV maker, Samsung, going to pay for a click on
their advertised sponsored link at the top? And then how much would they be willing to
pay for the same search on Amazon? ED HARRISON: A lot more. WHITNEY TILSON: 10 times more, right? Not double. And because, though, obviously– ED HARRISON:
Cause if– WHITNEY TILSON: –likelihood of making a buy– and when people are searching
on Amazon, they’re ready to buy. Yeah, people are searching on Google, they’re
just doing research– who knows. Those earnings from advertising is 100% profit
basically to Amazon and would be awarded a very high multiple by investors. ED HARRISON: And so what’s the downside risk
on that particular trade, that particular investment? WHITNEY TILSON: Look, a lot of this is you’re
looking out a few years, and there could be a general recession. Almost every day, there’s some sort of scandal. Just in the past week, there had been a story
about how Amazon’s same day delivery trucks have been in a bunch of crashes. Amazon doesn’t own them. It’s all subcontracted. There could be legislation, particularly under
President Elizabeth Warren, for example, that, for example, affects, not just Amazon, but
particularly Uber and Lyft that requires all of these contract employees to come on their
payroll. You have to pay them benefits and all. It would destroy Uber and Lyft, destroy their
business models. Amazon, it would just reduce their margins
a bit. And then there was a second article– another
article on Amazon– where there were all these sort of Chinese fakes being sold on the sites. And there’s more scrutiny about what Amazon
is selling. So I think Amazon has less regulatory risk
than Facebook and Google, which are affecting politics and presidential elections and things
like that. But so there’s definitely, though, some regulatory
risk there. Frankly, I’d love to have Elizabeth Warren
come in and force Amazon to split off Amazon Web Services. There’s really no reason that needs to be
part of Amazon. And I think that would unlock enormous value. Now, see, that’s the thing. The risk hanging over 2 of my other favorite
tech stocks, Google and Facebook. Those are my big 3. I’m a big fan of those. I am not at all a fan of Apple. I think Apple, just there’s no growth left,
whereas, I think Amazon, Facebook, and Google still have a lot of room to grow. Investors are concerned about the possibility
that the government, particularly under President Elizabeth Warren– and I think Bernie Sanders
is also called for their breakup. I think that would be a home run for investors. If Google spun off YouTube and Waymo, I think
those 3 pieces would be worth a lot more than they are combined. I think if Facebook was forced to re– they
bought Instagram and WhatsApp. If they were forced to spin them back out,
I think those 3 pieces are worth a lot more. So the companies don’t want it. They’re scrambling to head it off. I don’t think it’s likely. But I don’t view that as a negative for the
stock. If it happens, I think it would unlock value. ED HARRISON: Well, we’re going to have to
have you come back and talk to us about investment ideas. That’s something that I talk about on a weekly
basis, bi-weekly basis. And I’d love to hear some of your ideas coming
up. It’s been a pleasure talking to you. And I hope to have another conversation about
this again in the very near future. WHITNEY TILSON: Great, thanks for having me. ED HARRISON: Thank you.

13 Replies to “Is WeWork’s Demise a Positive Sign for Value Investors? (w/ Whitney Tilson)”

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