The Longs Of Whitney Tilson's Investor Letter

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After hedge fund manager Whitney Tilson split from partner Glenn Tongue of T2 Partners in mid-2012 he vowed to sell off some major stakes in the likes of Berkshire Hathaway, Goldman Sachs, J.C. Penney and Netflix in an effort to get the hedge fund to 70% cash. By doing so, Tilson would be able to start fresh. Thus, when Tilson sent out his 2012 investor letter for his new "Kase Capital" I figured it would be worth checking up on the stocks he owns (check out all of Tilson's picks). 

Tilson runs a concentrated portfolio, having only thirteen long positions as of the end of January. He had this to say about his high-concentration...

Since I took over as sole portfolio manager seven months ago, I have purchased/repurchased only eight stocks, seven of which have risen...I am pleased with the fund’s concentrated yet well-diversified long portfolio, which I believe will substantially outperform the market over time. 

Let's get to it. As of the end of January, Tilson's six through ten largest positions included (see the top five covered in part two):

Netflix (NASDAQ: NFLX) is Tilson's sixth largest pick and was Tilson's big pick at this year's Value Investing Congress, and he continues to have a strong affinity for the stock, continuing to note the similarities between Amazon in 2001 and Netflix in 2011, noting they have similar revenues, customer count and market cap.

The video subscription company has been growing subscribers nicely, and the stock is now up over 130% over the last three months. At the end of 2012, Netflix recorded some 27 million subscribers, up from the 21.6 million at the end of 2011. Although its 80x price to earnings multiple means little given the only potential competitor, Amazon, trades at a near 1000x P/E, investors should take solace in analysts' estimates for Netflix to grow EPS at 18% annually for the next five years. 

Some of Tilson's thought on Netflix includes...

...Netflix can’t be valued in traditional ways such as a multiple of current earnings, cash flows, and/or book value, so I value it based on a probability-weighted scenario analysis. At one extreme, what are the chances that, over the next 5-10 years, Netflix becomes a globally dominant, highly profitable entertainment/media company – in which case, the stock could be a 10-bagger from here? At the other extreme, what are the odds that subscriber growth slows, content costs rise, cash flows turn sharply negative, and Netflix has to either raise capital or sell itself on distressed terms – in which case, the stock would collapse? And what is the likelihood of various in-between scenarios? Last summer, the stock was priced as if the disaster scenario was a real possibility. 

Canadian Pacific (NYSE: CP) is Tilson's seventh largest holding and was Tilson's only new position in the fund since he took over. Worth noting is that billionaire investor and Greenlight Capital founder Bill Ackman had Canadian Pacific as his top 13F stock holding at the end of the third quarter (see all of Ackman's stocks).

Tilson's comments on the railroad company included...

It was a chronically under-performing railroad, plagued by an ineffective CEO and a complacent board. Well-known activist fund Pershing Square took a large stake in the company in late 2011 and, after unsuccessfully trying to persuade the board to remove the CEO, waged a successful proxy battle that resulted in a mostly new board and the hiring of Hunter Harrison as CEO. Harrison is a legend in the industry for the remarkable turnarounds he led at Illinois Central and Canadian National and, in owning this stock, I’m making what I think is a high probability bet that he’ll be able to do it again.

Canadian Pacific has under-performed many of its peers, but it now has initiatives to boost its operating ratio in the range to around 70% by 2016. Tilson also believes that it’s a good bet that Canadian Pacific will hit $150 within 2-3 years and approach $200 within five years. I too believe Canadian Pacific is executing a solid turnaround and continues to be one of the top railway companies (read more about my CP thoughts).

Tilson appears to be winding down his micro- and less liquid positions, including dEliA's, Grupo and Iridium, which accounted for about 30% of invested capital as of July 1, 2012, but at the end of January made up less than 10% 

dELiA*s, Tilson's eighth largest pick, recently announced it is seeking another CEO after current CEO Walter Killough departs in April. What's more is that the apparel company has been seeing steady declines in earnings over the last five years: 

<table> <tbody> <tr> <td> <p> </p> </td> <td> <p><strong>2008</strong></p> </td> <td> <p><strong>2009</strong></p> </td> <td> <p><strong>2010</strong></p> </td> <td> <p><strong>2011</strong></p> </td> <td> <p><strong>2012</strong></p> </td> </tr> <tr> <td> <p><strong>Earnings Per Share</strong></p> </td> <td> <p> $(0.08)</p> </td> <td> <p> $(0.41)</p> </td> <td> <p> $(0.34)</p> </td> <td> <p> $(0.70)</p> </td> <td> <p> $(0.73)</p> </td> </tr> </tbody> </table>

Tilson snatched up 10% of the company many years ago in the $2 range, but the stock only trades around $1 per share now. Tilson's thoughts sum up the company nicely...

Unfortunately, the company has been free cash flow negative every year and has thus steadily burned through its cash such that it now has only roughly 60 cents/share of cash and the stock is at $1.02. It’s been a classic value trap so far.

One big thing to look out for is a buyout of the company, which has a $32 million market cap. The niche apparel company was reported as putting itself up for sale in early 2011. The teenage apparel market appears to be crowded, and only getting more and more crowded. dELiA's was bought by Alloy for $50 million before being spun off two years later.

I remain cautious on this pick of Tilson's, the company has been under-performing for a number of years. Worth noting, is that Tilson has big-name fellow shareholders in dELiA's, including Royce & Associates and billionaire Jim Simons (check out Simon's top picks).

Grupo Prisa (NASDAQOTH: GPOPF) is Tilson's ninth largest long position, and trades at only $0.32 per share, and a $178 million market cap. The media conglomerate is based in Spain and has over 75% of its business in Spain and Portugal, which has been plagued by depressions and in turn has led to pressure on the company's earnings. Tilson believes that Grupo is...

...a good business with valuable assets plagued by two things: the terrible depression in the Iberian peninsula and a bad balance sheet. Thus, it’s not surprising that the stock has fallen sharply.

Tilson goes on to point out that the world’s richest person, billionaire Carlos Slim, owns a 3.2% stake.

Iridium (NASDAQ: IRDM) is Tilson's tenth largest holding and provides mobile voice and data communications services via satellite and was Tilson's tenth largest holding at the end of January. Over the past five years, Iridium managed to grow earnings over 47% annually for the last five years, but things remain bleak for the next five, with analysts' expecting the company to only grow EPS at 13% annually. On the other hand, Tilson continues to be a big believer of the company, saying this...

I believe this is an excellent company and the stock is significantly undervalued. Comparable businesses are trading at 9-10x EV/EBITDA, while Iridium, which is growing significantly faster than and taking share from its competitors, trades at around 6x EBITDA.

Don't be fooled. Tilson has had a tough 2012, seeing his fund lose 1.7%, compared to the 16% the S&P 500 gained. However, since inception, Tilson has returned 110.6%, which has managed to beat all other indices including the Dow Jones. Thus, it's worth taking a look at what he might be betting on for 2013, but I would be cautious about his three micro-cap picks, dELiA's, Grupo and Iridium. 

mhargra has no position in any stocks mentioned. The Motley Fool recommends Netflix. The Motley Fool owns shares of Iridium Communications and Netflix. Try any of our Foolish newsletter services free for 30 days. We Fools may not all hold the same opinions, but we all believe that considering a diverse range of insights makes us better investors. The Motley Fool has a disclosure policy. Is this post wrong? Click here. Think you can do better? Join us and write your own!

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