My conversation with Carson Block; Netflix debate; Problems at eXp World; Facebook Employees Have So Many Great Nicknames for Mark Zuckerberg
1) I had a lot of fun chatting last week with famed activist short seller Carson Block of Muddy Waters and his colleague Freddy Brick. You can watch the 46-minute video here. Here's a summary:
In this latest episode of The Short of It, Carson Block and Freddy Brick are joined by Whitney Tilson of Empire Financial Research who shares his insights in being involved in some of the largest short-selling battles of all-time. As a former long/short equity manager, Whitney explains how the current landscape might once again be swinging in favor of short-sellers after a challenging macro environment over the past decade.
The conversation moves to focus on idea generation and examples of some high-profile shorts, with further discussion around portfolio construction and trade management. The trio also explore the threat of rising rates for structurally unprofitable business models, and where Buffett and Munger got it wrong in overlooking other compelling growth stories.
2) During our conversation, Carson and I debated Netflix (NLFX) and Uber (UBER). Carson said both were structurally unprofitable, but I disagreed about Netflix.
Coincidentally, I saw this bearish analysis of Netflix's accounting by one of my former students, Steve Clapham: Naughty Netflix. Excerpt:
I believe that Netflix has been aggressive in its accounting for some time...
I would expect the actual charge in Netflix's financial statements to be considerably higher than my estimate, reflecting that content was being written down at an accelerated rate. I cannot understand why Netflix's amortization charge is not higher...
I continue to believe that the content numbers at Netflix are inconsistent with the company's stated policies. That is rarely a positive for investors. To value the company, it would be better to use the cash spend as a proxy for the expense.
I shared Steve's report with my colleagues, given that Netflix is a recent pick in our flagship Empire Stock Investor newsletter (find out how to subscribe and see our full report on Netflix, as well as all of our current and past recommendations, for only $49 for the first year by clicking here).
I commented:
I know Steve – he took the seminar I taught in London in July 2018. He's a smart guy, but I think he's wrong on this one.
Here's a screenshot of Netflix's cash flow statement over the last 10 years, and I see nothing unusual/suspicious:
In response, my colleague Berna Barshay added:
I really don't think there are accounting shenanigans here. Even in his final conclusion, where his projected amortization line is over the reported amortization line, the variance is so small in the bigger picture and largely confined to only 2018 and 2019. Earlier in the time series, it even implies they once under-amortized. The lines look pretty tight to me – if you are going to cheat... why not by more?
I have tried to model content amortization charges before in different situations and it is almost impossible to nail. It's something that you can only get in-the-ballpark right... you can't get it precisely from the outside. Plus, as you, Whitney, pointed out, the free cash flow has been trending the right way, which is a good sanity check.
More importantly – the accusation doesn't pass a gut check for me.
I know both "Spencers" – the CFO and the lead investor relations person – and they are straight shooters. Anyone who has had personal interactions with them will attest to that.
There is also no shortage of examples of CEO Reed Hastings being a stand-up guy – you, Whitney, even have a personal one, from back in those days a decade ago when you were briefly short the stock. Back in those early days, when this was a small company and it was much easier to get access to management (Reed still came to conferences and took meetings!), Reed never gave off promotor vibes as most of these guys who run accounting scams do. This is one of the last management teams I would ever expect to be involved in purposeful accounting misconduct.
You can argue 'til the cows come home about how profitable this business will ever really be. As I have said in various reports, daily newsletters, and presentations, there is a cap on industry profitability until we get some consolidation.
The risk here is that they make too much content to allow sustained, consistent, and improving free cash flow generation, whether because of necessity/competition or lack of discipline. It's the content spend that needs to become more rational, not how they account for that content that needs to be fixed.
Thank you for your trenchant (as always) insights, Berna!
3) Speaking of activist short sellers, a young guy named Edwin Dorsey (I wrote about him here: Would You Pay a 22-Year-Old Stanford Grad to Expose Wrongdoing?) tracks all of them and publishes regular summaries in his newsletter, The Bear Cave.
He also publishes his own research – this report from yesterday caught my eye: Problems at eXp World Holdings Inc (EXPI). Excerpt (subscription required to read it all):
eXp World Holdings ($2.77 billion) is a high-flying virtual real estate brokerage. Since going public through a reverse merger in 2013, eXp's stock is up over 3,500% fueled by rapid agent growth in a multi-level marketing model. The company's rise has been matched with dubious accounting, regulatory snafus, an SEC subpoena, high insider selling, and a questionable recruiting pipeline promoted by a prominent Scientologist.
eXp World Holdings was founded by Glenn Sanford in October 2009 as a "cloud brokerage" that saved costs by cutting out physical offices. Today, Mr. Sanford serves as eXp's CEO, Chairman, and controlling (~54%) shareholder. Before founding eXp, Mr. Sanford started his career helping companies go public through reverse mergers, and in 1998 Mr. Sanford formed eShippers, an outsourced logistics company that went public in a dot-com bubble reverse merger. Today, eShippers is a $2 million penny stock on the TSX Venture Exchange that is going through another reverse merger with an exploratory gold miner.
Like Mr. Sanford's prior ventures, eXp also went public through a reverse merger with OTC-listed Desert Canadians Ltd in 2013 and uplisted to the NASDAQ in May 2018. eXp earns money by charging its agents a $149 start-up fee, a $50/month technology fee, a $35/month education fee, a 20% cut of initial commission income, as well as transaction fees, errors & omissions fees, risk management fees, broker review fees, and mentorship fees. Since 2018, eXp's agent count has grown from 15,570 to over 71,000 today. That growth is aided by an aggressive recruiting operation, where realtors can earn cash and stock awards by recruiting other agents.
4) Following up on my comment in Wednesday's e-mail:
I'm most troubled by the idea of a totally untrustworthy, amoral, and weird guy like Meta CEO Mark Zuckerberg being the most powerful person on earth – and I truly think he is...
It turns out that his employees agree with me, as this hilarious 66-second video shows: Facebook Employees Have So Many Great Nicknames for Mark Zuckerberg.
Best regards,
Whitney
P.S. I welcome your feedback at WTDfeedback@empirefinancialresearch.com.