(Ep.41) The Acquirers Podcast: Vitaliy Katsenelson – Value Intellect, Softbank, Telsa And Value

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In this episode of The Acquirer’s Podcast Tobias chats with Vitaliy Katsenelson. He’s the CEO of Investment Management Associates, and the author of two books Active Value Investing and The Little Book of Sideways Markets. During the interview Vitaliy provided some great insights into:

  • Before I Got Into Investing, I Thought Investing Was Like Eddie Murphy In Trading Places
  • G.A.U.P – Growth At An Unreasonable Price
  • The Tablecloth to Napkin Financial Model
  • Historically, Markets Are Neither Bull Nor Bear, They’re Sideways
  • The Intellectual Investor – The Intelligent Investor Plus Creativity
  • Rational Investing – A Multiplication Of Your Investment IQ Times Your Investment EQ
  • Investing Someone Else’s Money Is A Huge Responsibility
  • There Is Both A Bull Case And A Bear Case For Tesla
  • SoftBank’s Disastrous Investment In WeWork – Everything You Need To Know

References In This Podcast



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Full Transcript:

Tobias Carlisle: All right. When you’re ready, sir, let’s get going.

Vitaliy Katsenelson: All right.

Tobias Carlisle: Hi, I’m Tobias Carlisle. This is The Acquirers Podcast. My very special guest today is my old friend Vitaliy Katsenelson. He’s the CEO of Investment Management Associates. He’s written one of my favorite books on investing, The Little Book of Sideways Markets that came out a few years ago. We’ll be talking about that in a little bit in depth. We’ll also be talking about Vitaliy’s philosophy on investing, life and lots of other things. We’ll be talking to him right after this.

Speaker 3: Tobias carlisle is the founder and principal of Acquires Funds. For regulatory reasons he will not discuss any of the Acquires Funds on this podcast. All opinions expressed by podcast participants are solely their own and do not reflect the opinions of Acquires Funds or affiliates. For more information, visit acquiresfund.com.

Tobias Carlisle: Hi Vitaliy, how are you?

Vitaliy Katsenelson: Hi Toby. I’m doing great. It such a privilege and pleasure to be on your podcast. You have such a great podcast. I’m a big fan, so.

Tobias Carlisle: That’s very kind. The privilege is all mine in this instance. I think that you have perhaps the best background story of anybody I’ve ever had on the podcast. You grew up in Russia and you came to the US and now you’re an investor. So can you talk a little bit about what was it like growing up in Russia and how did you get to the States?

Vitaliy Katsenelson: I didn’t grow up just in Russia, I grew up in a Soviet Russia, which is quite different than Russia today. So yes, I grew up in a city called Murmansk, which is above the arctic circle by maybe 150 miles from Norway, but the Northern part of Norway. So it’s very cold, very long winters, very short summers. Seattle looks like a sunshine state, I mean sunshine city compared to Murmansk.

Vitaliy Katsenelson: When I was growing up, I knew very little about investing. I think probably the first time I even thought about investing when I watched a movie was Eddie Murphy, Trading Places. [crosstalk 00:02:23].

Tobias Carlisle: Did you see that in.

Vitaliy Katsenelson: I think I saw it in Russia when I was still in Russia. And the time I thought investing was basically what we saw in the movie trading pork bellies and orange futures and a lot of people yelling at the stock, whatever, the exchanges. No, that was not even stack exchange then, that was commodities exchange in the movie. But that’s what I thought investing was. So if you ask me in late ’80s if I ever going to become an investor, I would have said, “Of course not. Who wants to do that?”

Tobias Carlisle: Too boring.

Vitaliy Katsenelson: Too boring, too chaotic and my voice, I can’t yell that much for that long. Anyway, in 1991 my family immigrated from Murmansk to Denver. And the reason I went to Denver, because my father’s younger sister left Russia in 1979 or 1980 and she moved to New York. She was in Brooklyn and there’s a movie, MozCon Hudson with Robin Williams. That movie basically described her immigration, very similar. By that time she moved to Cheyenne, Wyoming and thankfully she invited us to Denver, not to Cheyenne.

Vitaliy Katsenelson: There was nothing wrong with Cheyenne, but let’s be honest. Denver is probably more interesting place to grow up, to be in. Anyway, so I spent all my American life, which is now almost 29 years, 28, 29 years in Denver. Even when I came to Denver, I had no idea what I wanted to do. But at the time I did not speak English and I was 18 and half years old, almost 19. So I went to high school, which is very interested. In Murmansk I went to technical college, so I already graduated from high school, I went to technical college. When we came to Denver I ended up going back to high school because that was the cheapest way for me to learn English because the first year I went in Colorado [inaudible 00:04:27] State if you go to local school.

Vitaliy Katsenelson: So I went to high school, finished high school, and then I went to University of Colorado. And in the first couple of years at the University of Colorado, I did maybe, I don’t know, five or six different majors. I had more majors than girlfriends at the time. And the interesting part was that I really did not know what I wanted to do. And then I got a job at an investment firm, and they hired me not because of my business skills, but they hired me because I was good with computers, and they needed somebody to help them with computers. And they had a Bloomberg Terminal, the portfolio managers there were incredibly kind people, and we still friends.

Vitaliy Katsenelson: And at the same time I took a finance classes. I started to take finance classes. This is when I realized that investing is lot more than yelling at stock exchanges. I realized that investing is actually analyzing companies. And so, the kind of combination of me working for investment firm and taking finance classes I realized, “Oh my God, this is what I want to do.” And I was relatively young. I wasn’t Warren Buffett young, like 11 years old when he discovered he wants to be an investor. I was my early twenties maybe 22. 21, 22 years old. And I realized, “Well, I’m going to do investing. So for that I need to do CFA, I need to get my master’s degree in finance.” And so [inaudible 00:05:55] focus relatively early, like in early twenties. And so that was it. That’s, that’s how.

Tobias Carlisle: When did you join Investment Management Associates? Because it says you join them as an analyst and now you are CEO. So how did that?

Vitaliy Katsenelson: So I joined Investment Management Associates in 1997. I was one class away from graduating from University of Colorado, getting my undergraduate degree. Here’s the story. Originally I was PVG Asset Management, and they do not need another analyst. So I started looking for a job. What I did, remember this is early innings of internet, so this one, they still had yellow pages, I literally went to yellow pages, and I faxed my resume to every money management firm in Denver.

Vitaliy Katsenelson: So Michael Kahn, who’s now my partner, but then he was my boss, when he got my resume, he did not even post the job yet. So I was competing against nobody because it was not advertised. And I think to my luck, I was the only person he interviewed. So if I had any competition, probably I would not get the job.

Tobias Carlisle: So he was thinking about posting the job, but he hadn’t posted it yet. He needed someone, but he hadn’t looked.

Vitaliy Katsenelson: Yeah, his analyst left, and they were literally thinking about posting a job, and they haven’t posted it yet and they just got my resume in the fax machine. So basically I spammed his fax machine. I sent him my resume, and he interviewed me, and I get hired. There was a luck element in this. But at the same time, I did send out 200 resumes to everybody in Denver. So, there was some element of a persistence on my part.

Tobias Carlisle: Were you a value investor at that stage? Had you read Buffett’s stuff or were you still trying to work out what you were going to do?

Vitaliy Katsenelson: Yes, I knew I wanted to do investing, but I did not know that there are grades of investing. I did not [crosstalk 00:08:03].

Tobias Carlisle: How did you become acquainted with Buffett and value. How did that come about?

Vitaliy Katsenelson: So that came actually later in my career than I would like. So when I joined AMA, Mike was a GARP investor growth at a reasonable price, and he owned Walgreens at the time for 20 years. I remember at the interview he was showing me his position in Walgreens. He’s like, “Yeah, I owned it for 20 years.” And his cost basis at the time was like, I don’t know, 50 cents or something. He just bought it and never sold it.

Vitaliy Katsenelson: He was kind of growth at a reasonable price and that’s what he did. Mike was my mentor, and he’s still my mentor. He’s still my very good friend and we have very good close relationship. He basically introduced me to growth at a reasonable price investing, GARP investing. And Mike has done a great job managing our clients through the 1989 bubble because we did not participate in the bubble, which 1999 was painful because if you had any kind of discipline, 1999 you would been left behind.

Tobias Carlisle: You guys were still focused on the reasonable price part of the growth, not growth at any price.

Vitaliy Katsenelson: That’s right. We were focused on a reasonable price and that. Mike at the time he was doing it probably for 20 something years and he saw that movie before in the ’70s. So he stayed out of that bubble but then in 2002 was a very difficult year for us. And this led me to reexamine our process. And this is where I realized reasonable price may not be good enough. It should be unreasonable. And this is where margin of safety comes in. So this realization made me to explore first of all market cycles. And this is one of my research into my first book started to percolate. This is where I started to read more and explore other ways to invest.

Vitaliy Katsenelson: And this is when I discovered Buffett. So I came to Buffett later in the hindsight, as I would have liked. And this is where I really became little by little. Some people say they pick up the book, Intelligent Investor and they have this moment like this light going on and look going. For me it was a very slow process, but then over time it became a value investor.

Tobias Carlisle: What’s the difference between a growth at a reasonable price investor, and a Buffett style franchise, DCF style investor?

Vitaliy Katsenelson: God, this is a good question. I still struggle to find the difference. I think if you buy a company… Let’s step back for a little bit. Okay, let’s talk about what value investing means to me now, which has changed over time. If you and I talked 15 years ago, 10 years ago, I would have told you value investing is basically buying cheap companies, which would basically mean statistically cheap by below 10 times your earnings or low price to book or whatever. But I realize that’s a very primitive way to look at it.

Vitaliy Katsenelson: And value investing to me is a philosophy. It’s a philosophy, which is basically, I described the name. I wrote this chapter for my next book, which if I ever finish it, it will be in that book. But I call the six commandments of value investing. The old Testament has 10 commandments, this one has six. I didn’t want to compete with. Value investing is a philosophy where, and you know all of them, you trade stock as a business, not as a piece of paper or a symbol. You have a long-term time horizon. Mr market is there to serve you, not the other way around. You treat risk as a permanent loss of capital, not as volatility. In the long run stocks revert to their fair value, et cetera.

Vitaliy Katsenelson: So this is the six commandments. It’s a philosophy. And the interesting part, you can apply this philosophy to stocks that may not look statistically cheap. And I’m going to give you an example. So a few years ago we bought a company that was growing revenue very rapidly but was not profitable, it was losing money. I forget the numbers now, but we basically paid more of five times, five or six times sales and it was Twilio.

Vitaliy Katsenelson: And I did a write up on the Value Investors Club and I basically said by posting this right up, you guys are going to kick me out of the Value Investors Club because this does not look like your traditional value investment. But one thing I realized that actually you can apply this framework even to… At that price, I could have applied it to Twilio because a couple things, the company might’ve been losing money but it was losing money because they were spending $100 million in R&D.

Tobias Carlisle: Right.

Vitaliy Katsenelson: Which was basically… I’ll give you this example, which is really an account anomaly. When the Walgreens opens a store, it could just depreciate the cost of the store for a long period of time. If company invest in R&D it expands on day one.

Tobias Carlisle: Right.

Vitaliy Katsenelson: Okay. So if you look at Twilio and you say, okay, two things. First of all, their expenses are really too high because if you amortize the R&G investment over time, they actually would be making money, number one. Number two, this is a company that has fixed cost. If you’re certain the revenues will continue to grow, you cannot help but you see the margins expand. And this analysis, I realized, “If I’m very conservative with the sales, and at the time of growing 50% a year, I took them down to 20%. 20, 25%.

Vitaliy Katsenelson: In three years there would be trading at maybe two and a half times revenues, which is for software company that’s actually probably the low end, as bad as it gets. So I realized if I’m very conservative in the worst case I won’t lose money. So long-term time horizon, I was looking at three to five years out, probably five years out, there was margin of safety. So if you go through the six commandments framework, you can see how a company like Twilio would be able to actually fit into this framework and it was incredibly successful investment for us.

Vitaliy Katsenelson: I think the stock went from 25 to it’s over 100 today. But again, statistically, it would not fall into value investing. Anyway, so going back to your question, how I transitioned? I started out as looking at value investing as basic buying cheap stocks. And today, to me it’s more of a framework philosophy than just doing arithmetic say, “10 times earnings.”

Tobias Carlisle: That’s cheap.

Vitaliy Katsenelson: That’s cheap, yes.

Tobias Carlisle: I understand the process that you’ve gone through and I sometimes think growth at a reasonable price, you might correct me if I’m wrong about this, but I understand that you just looking at dividing the growth rate by the price earnings ratio and if you’re under one. I think is that you want to be below one, which indicates that you’re getting a sufficiently high growth rate divided by a sufficiently low price earnings ratio that you get. That’s a good position. So it’s just a simple rule of thumb. Whereas the Buffett stuff framework is more of philosophical, there’s more of thinking involved in the position. Is that a fair distinction?

Vitaliy Katsenelson: I think that is probably right. To me GARP was too limiting.

Tobias Carlisle: Right?

Vitaliy Katsenelson: Because, let me tell you the limitations of GARP. That it assumes, actually I wrote about this in my first book, it basically assumes that company can maintain this growth forever.

Tobias Carlisle: Right?

Vitaliy Katsenelson: Which is usually not the case. At some point if you grow at 20% a year forever, you become the economy. Or you become the industry. So you have to assume that the growth rate at some point will slow down and I still think in the terms of discounted cash flow analysis, because that corrals me into thinking about business. So if companies growing at a fast rate, I do have to make an assumption that at some point this growth will slow down. Otherwise it will become the industry. So GARP, as I started to use it more and more, I started to see limitations of GARP. And this is in part why I transitioned, what made me value investor not just a GARP investor.

Tobias Carlisle: Sometimes I find it, it’s funny though, that I point out that some of the best investors who I know, who are Buffett style investors, their analysis isn’t much more involved than a GARP style investment at the valuation point. Because we’ll simply look at, and they’re using some variation of Gordon Growth Model, dividend discount model, and approximately what are the cash flows this year? What’s the growth rate and what’s the appropriate discount rate?

Tobias Carlisle: And they just use that because all of the work is done on the business and all of the work is done outside of that. They’re just simply looking at what is a reasonable valuation for this company roughly. And then I’m going to go and do a whole lot of work and think about where this business is going to be in five and 10 years time and so on. So I think that sometimes value investment is kind of put the growth at a reasonable price, but I don’t mind simple rules of thumb for figuring out at a very high level whether something is worth considering further.

Vitaliy Katsenelson: Yes, so when we do analysis. For a company beyond we go to financial model. And this financial model, the first version of it is going to be able to call it a tablecloth model which is going to be evident the second. It’s usually very big and it’s usually we go in depth and if you analyze a drug company we actually going to go through every drug and try to have an opinion on every drug. If the drug company we would actually try to see okay, when is expiration date? When does a patent expire?

Vitaliy Katsenelson: And then we can assume the sales would decline by 90%. But again, we would for the drug company but go one drug by drug, if we analyzing retailer, we actually going to analyze it on a store level, et cetera. But at the end of the day the second model we are going to build is going to be a napkin model. Tablecloth napkin.

Tobias Carlisle: Right.

Vitaliy Katsenelson: We can only really build a napkin model if you really understand the business. Because actually napkin model, to some degree, it’s more difficult to build because at this point you really need to know the drivers of the business. And the one that we found for us, the easiest way for us to get there is start big and then shrink it. And I know we’re going to talk about this, but if you think about my progression in my books, my first book Active Value Investing was 275 pages, I don’t know, whatever. A 70,000 words, 75 charts and tables.

Vitaliy Katsenelson: And my second book, which was The Literal Book of Sideways Markets, all it is, it’s my first book compressed into the little Book. It’s the napkin version of my first book basically. But I tell you I could not write The Little Book without writing the big one, the first one. But at the same time I’m so much more proud of my Little Book because, first of all I was given a second chance as a writer to rewrite some things that five years later or whatever, three years later. But also I was able to throw out things that was not as important. Anyway, so the same thing when it comes to building models. Same thing.

Tobias Carlisle: That’s so funny. I did the same thing with mine. I wrote three; Qualitative Value, Deep Value and then Concentrated Investing and I combined them all. It’s a one and that third book is much, much shorter, much, much easier to read, much, much cheaper. But it’s probably, in my opinion, it’s the best of the one. So let’s talk about Active Value Investing and The Little Book of Sideways Markets. What’s the thesis and what are the implications for investors?

Vitaliy Katsenelson: Sure. So I got to give you the proper context. So I started to write Active Value Investing in 2005 and the instigator for the book was the article I wrote for Financial Times, maybe six months before that, where I basically made the case that if you look historically… Okay first of all, let’s break up. So when you look at the stock market over the last 100 years or so, you’ve had a secular trends and you’ve cyclical trends. Secular the markets that lasts for a long, long time, 10, 15, 20 years. And then you have a cyclical markets that it’s a kind of a volatility inside of those markets. So every time we had a low in bull markets, a long secular bull market, the market that followed was not a bear market, but it was actually a sideways market.

Vitaliy Katsenelson: Because when we think about market usually there are two terms, bull and bear. But in reality, when it comes to secular markets, you only had a one true bear market, which was 1929 market decline, I forget, 70%. But in reality, like if you look from 1966 to 1982 the market fluctuated a lot. You had probably 30, 50% declines, but it’s just up and down over a 16 year period and it really has not gone anywhere. Usually the sideways markets are followed by bull markets and then you have… That last almost from 1982 to 2000.

Vitaliy Katsenelson: And here’s the most important part. The sideways markets or bull markets are not caused by economy. The economic growth historically during sideways markets and bull markets was about… GDP grew about maybe 3% a year on a real basis. They’re really caused by swings of price to earnings. And in fact, I would argue this, if price to earnings always stayed at 15 times your earnings, if this became a law, 15 times your earnings, can go above can be below, then we would basically not have a sick kind of this markets, we would just basically have a very steady market growing about 3% a year with GDP. In reality, what happened was at the end of the sideways markets, PE was very, very low. And as the economy continues to grow and PE start to expend, the earnings’ growth was supersized by price-to-earnings expansion. So you had above average returns.

Vitaliy Katsenelson: And so the problem is the price-to-earnings growth is that when you go above average, when you start supersize into this growth, at some point gets level so high you can’t grow anymore. PE gets too high. And then what happens? The pendulum starts swinging the other way. And this is why you have sideways markets again. So this market cycles are really all about just human psychology, price-to-earnings going from one extreme to another and that’s happening time of the time of the time. However.

Tobias Carlisle: [crosstalk 00:25:14] Just before you go on, I love that idea and I went and looked at that independently and so with what you say, there are these very distinctive cycles and basically you use a Shiller PE or cyclically adjusted PE and you can find these and it’s ’66 to ’82 is a sideways market because the PE compresses over the whole period until in ’82 the PE is very low and then ’82 to 2000 there’s this massive bull market and there’s no real change in the underlying earnings. The earnings are growing at a pretty constant rate through the whole thing. It’s mostly PE expansion. And so then this is the thing I think that most people will be surprised by when it come to 2000 and since 2000 and you say to date that’s been a sideways market where PE is been compressing or is that not the case that we bought them in 2009, how do you use this going forward?

Vitaliy Katsenelson: So just realize in 2000 when I was writing my first book I was basically assuming we are going to have a semi-normal economy. And the economy, like if you look at GDP growth, it was semi-normal, one thing that I did not account for is that interest is going to almost zero or become negative in some parts. $17 trillion of debt today actually has a negative yields. If you try to explain to your spouse what negative interest rates mean good luck, because I can’t. Because I haven’t explained to my wife. So it basically means that I’m going to give you $100 and you’re going to pay me back $90 and my wife still doesn’t understand this, which is logical, she doesn’t. But anyway, normally it’s called default, when you pay less is usually default.

Vitaliy Katsenelson: But anyway, so I think what happened was if you had a semi-normal interest rates, the price-to-earnings go from above average, to average, through average, and stay below average and then people say, “I don’t want to own stocks ever again.” And this is where basically people give up on stocks and this is when the next bull market starts.

Vitaliy Katsenelson: The problem is we never got to this capitulation stage because the interest rate has declined so much that they just poured so much fuel on the market that stock price went up and never looked back. So I would argue that my Little Book or my books are more relevant today than they were even when I wrote them because we are approaching variations of 1999 again. So was I right in my thesis, I would argue that I was. But again, I’m describing a framework. This was not a forecasting, this is… In fact in my first book I had to draw some table and say, “Okay, I have no idea what GDP growth is going to be and I have no idea what the end in PE is going to be. But if you want to forecast, here’s a table. Put in your numbers, then you can figure out how long this markets would last.” Today we had a very high level again, so it feels very ’99 ish to me. So I think my books are as relevant today as they were when I wrote them.

Tobias Carlisle: I agree. And I’m not disputing the fact that we’re in a sideways market. I just think that we’re at the top end of that sideways market and if we see some of that PE compression, which we could easily see at some stage in the not too distant future, then it looks a lot more like a sideways market. If we go down the other side again, because we won’t have seen that advancement. You’re working on a new book, The Intellectual Investor. Do you want to give us a little taste of what that’s going to be about?

Vitaliy Katsenelson: So just realize that when somebody writes a book, they go to promote it. So this is one of those books that may come out five years from now or 10 years from now, but because to me it’s really… The first book I really wrote it like I had a bucket list item. That’s still probably the only item I had in my bucket list to write a book to make my father proud. My second book was really just… John violin sounds came back to me and says, “You have the big book. How about you write a little book? I’m like, “Great.” But this book I’m really writing for me, and this is really a book for me before I can tell. So the name of the book is going to be The Intellectual Investor.

Vitaliy Katsenelson: Basically, it’s a play on The Intelligent Investor. It’s the next iteration of intelligent investing into intellectual investing. Or look at it as basically intelligent investing plus creativity. This book is really for me, trying to become a better investor because good thing about investing, you can always get better, and if you don’t get better, then you actually get worse.

Vitaliy Katsenelson: So, this book is for me to get better. So there’s a cute story that I read it somewhere. I’m stealing it from somebody, but I don’t know from home. So this woman comes to Dalai Lama and she says, “Could you please talk to my son. He eats too much sugar.” Dalai Lama says, “Sure, but can you come back in a month?” The woman says, “Sure.” So she comes back in a month with her son. Dalai Lama looks looks at her son and says, “Stop eating sugar.” The woman’s bewilder. She was like, “I was here a month ago. You could’ve not told me the same thing?” He says, “Yes, but first I had to stop eating sugar myself.” So before I can tell others how to become intellectual investors, I probably should turn myself into one. So this is why this book might take a long time for me to write it.

Tobias Carlisle: I like that answer. I like the idea that it’s the intelligent investor plus creativity. What’s the creativity?

Vitaliy Katsenelson: So Ben Graham, if you look at The Intelligent Investor, it touched on this a little bit, but there’re two things you can get out of it, the recipe, which is buy cheap stocks. And this is what most people get out of The Intelligent Investor because it stares you in your face. You don’t have to be very smart. 10 times your earning is good, 15 times your earning is bad, eight times your earning is phenomenal. That’s the recipe. But then there is a philosophy. A case. My point is this, when Ben Graham was writing his recipe, he was not competing against computers. He lived in a different world.

Vitaliy Katsenelson: And if you look at the Buffett, it’s evolution, he started as a Ben Graham kind of cigar, but investor. And he evolved. And I would argue that you and I are still relatively young and we have a long runway ahead of us and we’ll be competing more and more against smarter investors. But more importantly against computers. If you are only applying quantitative principles, then you are disadvantaged because if you’re only left brain, okay, computers are left brain as well because it’s an algorithm.

Vitaliy Katsenelson: So therefore you’re coming to a fight with a knife and somebody has a gun. What I’m trying to do is figure out how can I compete in the world where I’m competing against computers, how can I outsmart them? And in my mind, creativity is part of that. And this is probably as far as I’m willing to go right now because this is still work in progress for me, but this is the kind of the why I’m doing this book.

Tobias Carlisle: So can we talk a little bit about your investment process as it stands now? So how do you hunt for companies to invest in and then what’s the process after you find them?

Vitaliy Katsenelson: Sure. So if you think about our investment process, so the Russell Fuller. He talked about three sources of competitive advantage. You have informational advantage, which if you have it today, most likely you’re going to end up in jail 90% of the time. So you don’t have that. And we aren’t looking for that. Then you have really analytical advantage and behavioral advantage.

Vitaliy Katsenelson: I am trying, it’s kind of interesting. I think it’s often difficult to say where analytical advantage starts, where it evolves into behavioral advantage because I feel like they are tied together. So analytical advantage for us starts at first from heaven, at long-term time horizon. And I know everybody says this, but for us it’s really when we build financial models we look four years out or longer. So it’s deeply ingrained in our investment process.

Vitaliy Katsenelson: So for me it’s not just lip service, it’s really important in our analysis. And the reason you want to do this because they’re competing against the institutional investors that have external environment shrinks the time horizon. So that’s number one, but number two, you can’t really have a long-term time horizon if your clients don’t have the time horizon.

Vitaliy Katsenelson: And so as a CEO of the firm, I have to make a decision that not every client is an appropriate client for us. So sometimes I have to say no to new clients, which is, guess what? It’s not easy job, it’s not easy. And sometimes I have to let go clients who are not appropriate clients for us. And that’s not enough, then you have to educate your clients. There was a tremendous assymetry of information between what I know about stocks and what my clients know about these companies. I buy a company and for them it’s just the three or four letter symbol. For me, we’ve just spend 200 hours of doing research.

Vitaliy Katsenelson: So I write this 20 page letters to clients, four times a year where I walk them through every decision they made in the portfolio. And I say, “If you bought at Twilio, here’s why.” And you have a five page write up explaining the business the way we see it. And there isn’t a support because at some point we’ll be punched in the face. At some point my client’s portfolio will decline, but my client’s blood pressure, if they’re with my letters will not fluctuate much because they understand what we own and why we own it. So that’s a long-term time horizon.

Vitaliy Katsenelson: Then if you look from behavioral perspective, I’ve written about this in the past and I think it’s a great framework. If you think about your total IQ, it’s really a multiplication of your investment IQ and at times your investment EQ, which is emotional quotient. So it’s something you can say it’s analytics X behavioral.

Vitaliy Katsenelson: So the reason it’s very important is this. I may understand the company very well, but if I’m not rational why I own the business, it doesn’t matter how well I understand it. So let me give you an example. So let’s say I have a friend who said that he will never break grocery stocks. And he never explained to me why, but I have a theory that maybe when he was eight years old, he was caught shoplifting or something, I don’t know.

Vitaliy Katsenelson: But let’s say he understands grocery business very well and his IQ is 150 when it comes to groceries businesses. But his EQ is 0.5. Remember, EQ cannot be greater than one. So the most total IQ could be 150. But if EQ is less than one, then suddenly it starts reducing your total IQ. So at some point you get punched in the face and you’re going to have to make a rational decision. And if you’re an emotional wreck, that IQ is irrelevant.

Tobias Carlisle: Right.

Vitaliy Katsenelson: So therefore, Warren Buffett talks about your soak of competence and you usually think about it when it applies to your understanding of the business. But it also should apply to your EQ. Okay, yes, I understand the business, but am I a rational investor when it comes to own in this business?

Vitaliy Katsenelson: So for me, I find that I’m not very irrational when it comes to owning low quality companies. When I own companies whose businesses linked very tightly to commodities. So therefore we don’t have them in our portfolios because I know my limitations. So that’s where your behavioral edge counts. Also, it’s interesting. So when you play chess and you go to the tournament, you don’t have a choice in choosing your opponent, right? So you come to the tournament and you have to play the geekiest guy who only thinks about chess. In investing, I can come to the tournament and they say, “You know what, I want to play against this guy who works out six hours a day and he’s here just because he loves to bet.”

Vitaliy Katsenelson: That’s what investing is. I can choose my opponent. I can choose stocks to invest in. So if there’s an area which I don’t understand, I don’t have to invest there. So anyways, so when I was thinking about competitive advantage, it’s not just one thing, it’s long-term time horizon. It’s being more rational than others. It’s doing very deep research and when you get punched in the face is actually be able to stay rational.

Vitaliy Katsenelson: Also, I run a roll to this small firm and compete against giants. And I look at it as an advantage because we don’t have an institutional imperative of creating a portfolio that looks like Noah’s Ark. Warren Buffett calls it Noah’s ArK where you want two of everything.

Vitaliy Katsenelson: So we are like most institutional investors today are forced to… Consultants look at their portfolio and compare them to the S&P 500 or whatever the index compared to and say so what happens institution investors have to underway or overweight industries, et cetera. We don’t do any of the stuff. We just basically buy high quality companies and we buy them cheap. So we don’t market institutional clients and we don’t want them to be our clients. So we don’t have the handicap in us.

Vitaliy Katsenelson: Also, I have a huge resource network. They have a conference every year VALUEx Vail and they limit it to 40 people. It’s not-for-profit conference where you have other investors that hard investors, come and share ideas. And over the years I was able to build a huge network of people I talk to on consistent basis. So I have flows of ideas coming, not just from me doing screen or reading Value Investor Club or doing other things. I also get to have exposure to a lot of ideas coming from my resource network. So, that describes part of our process I guess. But I’m not sure which [inaudible 00:41:24].

Tobias Carlisle: No, that’s good. Anybody who mentions chess, I always ask what their favorite opening is.

Vitaliy Katsenelson: Oh my God, you know what. I go back and forth but I probably just go to e2-e4. So, that’s at the end.

Tobias Carlisle: I like to play the English. We had just had Connor Hayley on and he likes the bird just because it’s a very weird opening. But sorry, I interrupted. Keep going.

Vitaliy Katsenelson: But anyway, so at the end of the day you want to have resource process, which allows you to be as rational as possible. And that’s my goal. I want to be as rational as possible with my portfolio. And because you’ll get punched in the face, that’s just. And then what you do after that, that’s really going to determine your returns at long run.

Tobias Carlisle: I want to talk about rationality and irrationality in relation to a particular stock in one moment. But just before I do, just talk to me a little bit about the portfolio. How do you think about sizing positions do trim? How many positions do you hold? What does the portfolio look like?

Vitaliy Katsenelson: So for me to talk about this, I have to understand who my clients are. I really have two type of clients. People come to me and say, “Vitaliy, here’s my life savings. Don’t screw it up.” And so in this case, we would have what I would call a diversified portfolio where a position sizes will go from three to 7% and you probably going to have 25 positions. And position sizing. And it’s going to be the case in both portfolios, the second portfolio I will discuss as well. But it’s basically the higher the quality of the company and the cheaper it is, the larger the position is. And the lower the quality and the more expensive it is, the lower position size, it’s all relative.

Vitaliy Katsenelson: So you would have 7% positions if it’s an incredibly high quality company and it’s the incredibly, insanely cheap. And so that’s the diversified portfolio. And then I have clients who say, “Vitaliy, PE is 10 or 20% of my life savings. Please invest it for me.” So in this case I could be more aggressive and position sizes would go from seven to 15% so it’s a much more focused portfolio. It’s not appropriate for a client for whom I manage all their life savings, but it’s appropriate for client for whom I have maybe 10, 15 or 20% of their total portfolio.

Vitaliy Katsenelson: So, that’s how we position size. And one thing it’s very important is that we are very formal leg when it comes to position sizes because we want to control our emotions. You’re going to like this, we have a quantitative process where we figure out. Every company we rate A, B, C and D on quality. And if it’s A company that at some point it could be someone presupposition. If it’s a B company it will never be more than 5% position.

Vitaliy Katsenelson: And so we are doing company analysis and figure out what quality it is and what discount to the fair value is. And that basically in a formal leg basis leads us to position sizing. We try to keep it, because you know how it is. You fall in love, you’re like, “Oh my God, this is the best company ever and I love it to death and let’s put 20% of the portfolio in it.” We don’t do that. And this is the serious point, when you manage somebody’s life savings, it’s an incredible, incredible responsibility and therefore we take it incredibly seriously because yes, I’m not taking people out of burn houses. I’m not doing God’s work, I get that. But at the same time, when you have somebody’s life savings, you’re not going to have any more money. This people, that’s all money they ever going to have. You really don’t want to screw it up. So this is why we are so thorough with our process. This is why we have tried so hard to be rational. Anyway.

Tobias Carlisle: That’s a great answer. Let me segue away from that. And let’s talk irrationality and rationality when it comes to Tesla.

Vitaliy Katsenelson: Oh my God. Okay. So, Toby, I rode a thirty… I’ll start from afar. I bought model three. And a normal person would just enjoy driving it. And I did enjoy driving it, but then I ended up writing the 37 page article, 11 per article, which people can find on my website. It’s everything. So to me it was interesting because I was blown away how great the car is. And I realized that electric car is the car of the future. I’m not saying Tesla is the company of the future, I’m just saying I can see how internal combustion engine cars would go. IC cars are basically the horses and the electric cars are the cars of the future basically.

Vitaliy Katsenelson: As an investor, there are so many implications there. So one thing I realized as an example that people think about General Motors, et cetera, and Ford. And for them it’s a foregone conclusion that General Motors would be able to make great electric cars and that their market share will be the same in electric cars as it was in internal combustion engine cars. And I would argue that may or may not be the case.

Vitaliy Katsenelson: Let me give you this analogy. When into Southern seven iPhone came out. Nokia, Motorola were the biggest cell phone makers in the world. And you would think that five years out, 10 years out the iPhone is going to have a small market share, Apple is going to have small market share and Motorola and Nokia will dominate it. That’s not what happened. And the reason for that, because even though iPhone was called that kind of “I” had “Phone” in its name, it was really smartphone, which is really a computer.

Vitaliy Katsenelson: So when you went from dumb phone to smartphones, you really went from one domain where the hardware was the most important part into another domain where making phone calls actually was the least important part.

Tobias Carlisle: Right.

Vitaliy Katsenelson: Therefore it requires a very different skillset. So when you made dumb phones interface was not as important, software was not as important. The factors that mattered in the dumb phones didn’t matter as much. But also happens when you go from one domain to another, your assets become your liabilities. And this is incredibly important point to understand. If you had 5,000 engineers that focused on, I don’t know I’m just making this up, on plastic. Whatever that is, whatever the dump phones expertise was. Those engineers become liability because their knowledge actually weighs you down.

Vitaliy Katsenelson: So when a iPhone came out, Nokia should’ve looked at Apple and said, “Apple, thank you so much because now we know what the future product is going to be like.” Nokia did actually, they took their Symbian, which was their software for the dumb phone and try to convert it into a smartphone software. That failed miserably. So it’s like General Motors they are trying to take their internal combustion engine car and turns to hybrid. Then you have a Volt and Bolt and none of them are good cars.

Vitaliy Katsenelson: So my point is this, today Tesla is the largest electric car maker in the world. And another point is very important to understand, the reason Tesla is losing money. Not because it’s not good company, it is because it’s very expensive. You need to get to scale and even at half a million cars a year, this does not produce in today more or less, it’s still a sub-scale.

Vitaliy Katsenelson: So for General Motors to transition to electric cars, it’s going to have to lose a lot of money too. I think over the last 10 years, Tesla Komatsu lost 25 to $30 billion. Guess what? That’s the General Motors of the world. And I’m not just picking on General Motors, just it’s comes every car company can think of, they’re going to have to lose a lot of money. And that is a lot more difficult than you’d think.

Vitaliy Katsenelson: There was a great article about Walmart on Recode and talking about Walmart’s pains of competing with Amazon. Walmart five years ago I think bought Jet.com and the guy who was running Jet.com is running Walmart.com today. Amazon carries 300 million SKUs. Walmart store has about 150,000 SKUs, items basically. So Amazon has 110 distribution centers in United States, Walmart has I think 10 or 12. So for Walmart to be able to compete with Amazon, they need to expand their distribution network. And they have to start carrying a lot more items. Walmart.com is losing billion dollars a year. and the board absolutely hates it because it’s not in the Walmart’s culture to lose money.

Tobias Carlisle: Right.

Vitaliy Katsenelson: And so the article described the tension between Walmart.com CEO and the board and in fact they’re pushing the Walmart.com CEO to lose less money. The losses come because they’re subscale. So long story short, if you look at the traditional car makers, the transition to electric cars will be very painful. I’m not saying that they won’t be able to transition, all I’m saying is it’s not a given that they will all transition well.

Vitaliy Katsenelson: And if you think about it yes, Nokia kind of became irrelevant. Motorola became irrelevant. But Samsung today is one of the largest maker of cell phones still, smartphones, even though. So it was able to transition. So some companies will do a better job than others. But to me today as an investor, I look at the General Motors and Fords and they are to me uninvestible. At some point that may change. That was another conclusion of the article.

Tobias Carlisle: Does that make you a Tesla Bove? Does it make you a Tesla long?

Vitaliy Katsenelson: That’s a good point. Normal person wouldn’t… He writes 37 page article, he stops. Not me. I wrote another two part article about this. And basically this is where it gets interesting. I can see how Tesla could basically decline 75%. And it’s very simple. This is a company that’s losing a lot of money and at some point we may have a view work moment where the markets will stop financing its losses.

Tobias Carlisle: Right.

Vitaliy Katsenelson: And then the stock price will decline. They would have to issue a lot of equity and if your equity shareholder will get diluted and maybe at some point we get bought out at $10 billion valuation, which would be 75% decline. So I can see that.

Vitaliy Katsenelson: I can also see how… Right now they have a run rate about half a million cars a year roughly. At some point I can see how they could be producing one or 2 million cars a year. And if they do this they would have much, much higher earnings. And then you can see the stock price going up three, four, five fold. So I can see both sides. Here’s the struggle I have no idea what probability to put on each one.

Vitaliy Katsenelson: So I’m neither bull nor bear, but there is… It’s funny, the very last part about, in my Tesla series I wrote about tribalism. And this is probably the most favorite 800 words out of 16,000. It’s almost like a Little Book. And that was actually my favorite part by far. Because if you go on Twitter and you type TSLA, which is Tesla, you’ll see a lot of people who are raving how much they love the car like I am and how [inaudible 00:54:15] is great, et cetera. And then if you add a Q at the end TSLAQ, you have Tesla Q. Basically the Q comes from this. When a company goes bankrupt, you add Q to the symbol. So when GM went bankrupt, I think they added the Q. So this is Tesla bears.

Vitaliy Katsenelson: And so, you have this tribalism, you have Tesla’s versus Tesla Q, you have bull versus bears. And I was thinking about it, some tribalism is actually good. Like I’m very tribal when it comes to my family. My kids know that no matter what, I’ll be on their side. And this is like when we were cavemen and we were in one cave and there were tigers outside, we were tribe. It was us versus them. It’s us versus a tiger. So that’s where tribalism came.

Vitaliy Katsenelson: And tribalism is probably good in sports. My partner Mike went to CU Boulder and CU Boulder in Nebraska don’t like each other. And so he had a sticker on his desk a few months ago in August said, “Don’t wait till September, start hitting Nebraska now.” That is a true CU Boulder fan. And so that is harmless, it’s a very harmless tribalism I guess. Unless you are kind of a soccer fan in Brazil, then it becomes a very different story. And you have a tribalism in politics. I’m not going to go there, but when it comes to investing tribalism is very dangerous because there is no them.

Vitaliy Katsenelson: If I’m a bull, if I’m positive on Tesla or on any stock and somebody has a different opinion, it’s not them. I should look at them as my friends because what I should be trying to do is figure out where could I be wrong. There was this great saying by Seneca, “Time will discover the truth,” and so the truth in this case has really fundamentals. What will this company’s earnings going to be five years from now, three years from now, what the price-to-earnings going to be and how this business will look like.

Vitaliy Katsenelson: If somebody has a different opinion from me and that opinion is derived from doing research, I should embrace it. I should actually try to go out of my way to figure out what they’re thinking. There is no them in investing, so this is not us versus them. And I learned that in Jewish law, which is kind of interesting, when you have a capital punishment case, if a jury commerce was unanimous guilty decision, then the person is let go, goes free again. I’m going to repeat it again. If the guilty decision is unanimous, let the person go. Which is counter intuitive, right?

Tobias Carlisle: It’s.

Vitaliy Katsenelson: Yes. But their thinking is this. If there was not a single person who disagreed, most likely the decision was not well thought out. Okay?

Tobias Carlisle: All right. That’s great.

Vitaliy Katsenelson: We encourage this healthy debate because again, we’re just looking for the truth and that’s what investing is about. The search for the truth to some degree, because again, time would discover it at some point anyway. So we just want to find it before time does. There was this comedian, Milton Barrow who said “I used to be bullish, then it was bearish and now I’m broke ish.” Okay. So my point is just don’t be tribal ish then you won’t be broke ish. So, that’s my Tesla ARK.

Tobias Carlisle: I liked that, I think that’s great analysis. You make a very compelling argument. Talk to me a little bit about the SoftBank WeWork fiasco that’s going on right now. And is there a VC bubble? What’s the impact of SoftBank on the market?

Vitaliy Katsenelson: So this is actually ended up being one of my most controversial investments. We bought SoftBank in 2015. At the time nobody knew what SoftBank was. I think when we bought it, my clients said, “Why are you buying this Japanese bank?” I mean really.

Tobias Carlisle: I don’t remember Masa Son from the first dot-com boom.

Vitaliy Katsenelson: That’s right. No that’s right. I guess they didn’t but so yes. So when you’re buying SoftBank at the time, and this is very important to understand why we bought it. At the time SoftBank owns some assets, it owned at the time it still does Japanese telecom, which is the third largest telecom in Japan. And when I say third let’s say like the market share is maybe a few percentage points behind number one, number two. So it’s still very large at scale telecom. It own almost half of a Yahoo, Japan. And it owns at the time 30% of Alibaba, now it’s 25%. So if you just literally took the sum of all these three companies and took out that you would realize if you are buying SoftBank at the time, 50 cents on a dollar.

Tobias Carlisle: Why the discount?

Vitaliy Katsenelson: Here’s the discount. So the reason the discount happened was because SoftBank also bought Sprint. They bought 80% of Sprint and so Sprint was true public equity, it was public entity and Sprint when SoftBank bought it, they thought they would be able to merge with T-mobile. That did not happen and Sprint was bleeding money, had a 30 plus billion dollars of debt. So two things happened, first of all, investors, what they did, they took Sprint’s debt and consolidated to… Accountant rules say if you own majority position of something, you have to consolidate that. And I see the logic behind it, except Sprint was a separate legal entity. If Sprint went bankrupt, SoftBank could not be responsible for that debt. That’s point number one.

Tobias Carlisle: So for accounting purposes it was consolidated, but it was non-recourse to SoftBank. It would’ve been bad if they’d lost it, but it wasn’t necessarily going to be fatal to the mothership.

Vitaliy Katsenelson: That’s the point. Exactly. There was another point, if you do the math, if Sprint would go bankrupt, then the value of SoftBank would decline, but it was still significant margin of safety. In other words, even the sum of all the assets I mentioned, still was worth more, even if Sprint went to zero. So that was another one.

Vitaliy Katsenelson: So this was our contrarion view and we looked at SoftBank and we thought it’s run by phenomenal CEO. I got to explain that. Everybody thinks Masayoshi Son today is not a genius, I’m going to be kind. But let me just give you a perspective on him.

Vitaliy Katsenelson: So when he’s 18 years old, he comes to United States. He graduates from high school and Stanford, I think, I forget, one of the colleges in California, like in half the time. When he think he’s 19 he invents a translation computer that translates from Japanese to English or vice versa, sells it to Sharp $4 million. Remember, this is 1970 where million dollars was really a lot of money. And he’s not even 20 years old yet.

Vitaliy Katsenelson: Then he goes to Japan and he tries to figure out what he’s going to do for the rest of his life. Masa realizes that computers are the future, he start SoftBank, which was a software distribution company. Then he sees the internet is the future and he starts investing in the dot-com stocks before even dot-com is on anybody’s radar and he makes a lot of money. Then he does [inaudible 01:02:35] then at some point, in all fairness, he was not responsible for the SoftBank stock being sold, no. I forget what the price was at the time, but it was insane.

Tobias Carlisle: It was often 99% right from, Oh, sorry. But you haven’t yet.

Vitaliy Katsenelson: No, no. [crosstalk 01:02:50].

Tobias Carlisle: This is where it got to at the peak.

Vitaliy Katsenelson: Yeah. Maybe true, I don’t know. Maybe it got to some kind of insane valuation and it decline in 99%.

Tobias Carlisle: Right.

Vitaliy Katsenelson: So the original valuation was too high. Probably declined was probably too much as well. But anyways, he survives the bubble, even though it did decline. If you look at the extremes it did decline 99%. Then he sees that the internet is coming to China and the commerce is coming to China. He invests in Alibaba, which is probably the best investment ever made. $100 million is worth over $100 billion today, probably more than that. And this is where it gets interesting, he sees that the future is in smartphones.

Vitaliy Katsenelson: In 2005 or 2006 before iPhone it was introduced, before anybody had an inkling about iPhone, he came to Steve Jobs [inaudible 01:03:53], which looked like an iPad with some digits on it, honest to God. And he looking on it and then he says, “Steve, you should make this phone.” And Steve Jobs says, “Masa, you do your thing, we make phones.” But what he did, Steve Jobs promised him if they make a phone Masayoshi Son will get exclusivity on this phone in Japan. The only problem is that at the time he did not even own a telecom in Japan.

Vitaliy Katsenelson: So he goes out and buys Vodafone KK. And he buys it at the time it’s the worst run telecom in Japan. For two years, he works incredibly hard and he turns it around. Today it’s one of the best telecoms in Japan. iPhone comes out, they get exclusivity for iPhone that propels the telecom into where it is today. And so this is the person who created SoftBank. And just realize this, he does not have a flawless track record, he did make mistakes. But he did build a company. He’s the second richest person in Japan. Just completely created that. He built a company that’s worth $100 billion on his own.

Vitaliy Katsenelson: If you look at his investment track record, even if you take out the Alibaba, it’s still incredible. It’s like 30 plus percent a year over a long period of time. So it’s still very impressive track record. So that’s what Masayoshi Son. So we look at this, we are buying basically a dollar at 50 cents and become Masayoshi Son. Okay?

Tobias Carlisle: Right.

Vitaliy Katsenelson: So far so good. And so throughout ownership the discounts stayed the same, but the value has gone up. So the dollar became two dollars basically because the Alibaba went up in price and also in our analysis at the time, telecom Japan was not a public company. It was still private. So our assumptions on valuation was more conservative than where it’s trading today because about six months ago they took it public and they took it public at much higher multiple than we were while valuing it on our conservative assumptions.

Vitaliy Katsenelson: So that’s so far so good. So Ben comes out with his Vision Fund one. And this is where the bubble and they were going to commit $25 billion of their own money and then $75 billion will come from other investors. And so I’ll be honest, I was never a big fan of this because it’s so much money. So the rationale behind this funders is this, Masayoshi Son thinks that we’re going to have singularity. Singularity is basically where computers become smarter than humans, which I think is going to happen at some point I just have no idea when. And he wanted to invest in the companies in the early stages that would benefit from this. So the problem is that the private markets are relative to small markets.

Vitaliy Katsenelson: So when you have $100 billion infused to [crosstalk 01:07:21] markets, it distorts it. Yes, exactly. And so we were worried about this, but we went back to our models and we said, “All right, so what is SoftBank worth if that $25 billion they put in is worth zero?” And the margin of safety was still very, very high. There was still maybe 50 cent dollars, maybe it becomes 60 cent dollar, I forget the numbers now, but it was still significant lender value.

Vitaliy Katsenelson: Again, I’m not buying into the bubble. I’ve been very conservative in assuming that Vision Fund one is worthless. Even though at the time had a very good return. And then he buys into WeWork and we look at WeWork and we are stunned because three years ago, we analyzed a company called… At the time was called Regus, now it’s called IWG, which is basically WeWork. There were WeWork before WeWork was WeWork.

Tobias Carlisle: Dot-com at one point they were WeWork.

Vitaliy Katsenelson: Yes. And all you do, you enter into long-term leases and then you enter into short-term leases. You borrow long-term, you lend short-term. That’s how it is. WeWork had that business plus they also had beer fountains and pump on tables and they were losing money. That was basically it. And so I was very skeptical of that. But again, in our analysis, we assumed that Vision Fund one is worthless. So if things blow up there, yes, the stock price will get impacted in a short-term, but the permanent loss of capital would not be there.

Vitaliy Katsenelson: Then Masayoshi Son announced his Vision Fund two. And if you look at my last article I wrote about this. If you read between the lines, I was worried because at this point they were going to put in $40 billion into $100 billion fund and that money would come from SoftBank. So now I’m worried because now you add significant leverage to the company. That was my worry number one. I already had some trepidations about SoftBank and then when WeWork blew up there was an inkling that they’re going to put in their own money, the money they are going to try to bail it out, we sold the stock.

Vitaliy Katsenelson: And let me tell you why. Number one, so remember when we bought SoftBank, our thinking was that the discount at some point will go away. So at some point it’s going to start trading maybe 80 cents on a dollar or 90 cents on a dollar. Here, I see that if they start bailing out WeWork, the bail out is not going to come from Vision Fund, it’s going to come from SoftBank. So suddenly solving that balance sheet will balloon. That’s number one. Number two, when Sprint and T-Mobile merge, the debt will migrate from SoftBank balance sheet to T-Mobile’s balance sheet.

Vitaliy Katsenelson: And my thinking was that at some point they will sell Sprint and they’re going to have very good balance sheet. Now I start seeing that this may never happen because if the WeWork is going to become a sinkhole for the capital that will continue to say hi. And now I realized also that well if they put money, the another risk is that Vision Fund one may never happened in the way they envisioned it originally and the SoftBank is going to have to put in even more money of their own money.

Vitaliy Katsenelson: So realized that this company will never have a clean balance sheet and that discount may remain permanent. This is when I realized we’re going to sell the stock and then we’ll watch from the sidelines. If Masayoshi Son is a very smart guy, if he shuffle things, changes strategy, et cetera, we might come back and buy it later. But today I can see how… Yes discount is there today but the risk is that the value will decline in the future because that will go up and then discount actually will never narrow. So that’s why we sold the stock.

Vitaliy Katsenelson: Here’s the interesting part about VC bubble. So just think about this for a second. I’m the person who, and I wrote an article about VC bubble, because you do have a dot-com point two bubble is happening in private equities today. Because if you are a startup and you have a venture capitalists giving you $10 million, let’s say give you $1 million, a $10 million valuation, they give you this million dollars and say, “Grow.” So you take half a million dollars, you hire engineers, you take another half a million dollars, give it to Facebook and Google and start advertising. At this point, you’re not really focused on profitability. All you want is growth.

Vitaliy Katsenelson: Six months later you have a round B. Now you have larger revenues, you’re still losing money and you’ve been valued at $100 billion and the venture capitalist gives you another $10 million. So you spend some of that money on hiring more people and creating a product and a lot of that money goes to Facebook and Amazon and Googles, et cetera. So what happens is this, that you have a bubble developed because you’ve been valued in revenues and profitability is not really important.

Vitaliy Katsenelson: The only problem is you’re going to have this WeWork moment happening where markets… Because you’re losing money, you always rely on the kindness of strangers and you’re always rely that they’re going to be greater fool going to give you more money in the future. At some point you’re going to run out of greater fools and then you’re going to have a bubble burst. So imagine I have this mentality and then SoftBank is one of the propagator, the instigators of the biggest ball. SoftBank is actually blowing up this bubble. And so you do have this conflicting thoughts. And the only solace we had is that the, I can [inaudible 01:13:41] Vision Fund one, I can say, “Okay this thing is zero, the rest is still worth a lot more than the [inaudible 01:13:50] than where the stock is trading today.”

Vitaliy Katsenelson: I feel like also I’m partially responsible for WeWork bubble because I wrote so many positive articles about Masayoshi Son and maybe he read them and maybe went to his head and he’s like, “I walk on water so I,” anyway.

Tobias Carlisle: “I really am a genius.”

Vitaliy Katsenelson: Yes. I think this is very important lesson, not just from Masayoshi Son but for everybody. The market is such a great humbling machine. If you feel you’re great, just wait six months and the market is going to tell you. It’s going to bring your self esteem down a little bit.

Tobias Carlisle: I couldn’t agree more. Vitaliy, I’m sad to say that we’re coming up on time. It’s absolutely flown by chatting to you. If folks want to get in contact with you, what’s the best way of doing that?

Vitaliy Katsenelson: Yes. They can read my articles on contrarian edge E-D-G-E.com, contrarianedge.com.

Tobias Carlisle: We’ll put that link to that in the show notes as well.

Vitaliy Katsenelson: And we have a podcast, which is not as great as yours. And it’s actually, it’s not even a podcast, it’s really kind of articles on tape. When I write articles, you can listen to them read to you by professional narrator, so you won’t have to listen to my voice.

Tobias Carlisle: That sounds great. I should get that for my podcast.

Vitaliy Katsenelson: And just go to investor.fm. Investor.fm like FM radio. So any of you can listen to them there.

Tobias Carlisle: Got it. Vitaliy Katsenelson, thank you so much.

Vitaliy Katsenelson: Toby, it’s my pleasure. Thank you very much.

Tobias Carlisle: And that’s it.

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