Whitney Tilson’s February letter to investors came out last week.
In it he reports that his fund gained 4.1% vs. 3.4% for the S&P 500.
That’s good, especially since on the last day of the month, his fund has a “historic” bad day, when a recent investment move — his big bet on legal expert witness company LECG — went totally sour.
His explanation: T2 just got unlucky.
Here’s what he says:
It was a historic day for us on the last day of February – but not in the way we like: one of our positions declined by 80% in a single day. You might think that such a decline is, ipso facto, proof of a mistake, but we’re not so sure (and that’s not just because we had a good day and month). Allow us to explain…
LECG is a specialised consulting firm that “conducts economic and financial analyses to provide objective opinions and advice that help resolve complex disputes and inform legislative, judicial, regulatory and business decision makers.” Our investment was based on the belief that LECG could successfully integrate recent acquisitions into a profitable business structure. Given the company’s market capitalisation of approximately $40 million, we felt that we had a reasonable margin of safety imbedded in the company’s $109 million in Accounts Receivable, offset by $26 million of net debt.
The company’s distressed stock price, under $1, was due to a default on the existing debt. Given the quantity and quality of the receivables, we believed that the default was a short-term issue and that LECG would be able to refinance debt on a secured basis, supported by the Accounts Receivable, in which case the stock could easily be a multi-bagger.
Much to our surprise and dismay, however, LECG instead announced what is effectively a plan of liquidation. We don’t know why the company pursued this path, though it is possible that this route preserved compensation agreements for employees at the expense of existing shareholders. Given the rapid execution of the liquidation, we believe the equity will end up being worthless so we sold our entire position.
In light of this permanent loss of capital, why aren’t we certain that this was a mistake, as Netflix clearly was? Because it’s possible that we made a high-expected-value bet, but just got unlucky. Investing is a probabilistic business so it does not necessarily follow that every time you lose money, you made a mistake (and, conversely, every time you make money, you made a good investment). This is very simple and, to us, obvious, but is very poorly understood.
He goes on to say that this was a classic mis-priced option, essentially, and that when presented with similar situations again, he’d take it.