In their recent episode of the VALUE: After Hours Podcast, Jake Taylor, Bill Brewster, and Tobias Carlisle discussed Is Averaging Down A Good Investment Strategy? Here’s an excerpt from the episode:
Jake: There is an interesting game theory that plays out in this take-under situation, where you almost have a big pot committed where you have to keep averaging down your price so that when the buyout does come you’re at least like– it will typically be over at least what the market price had recently been at. So, you almost hedge your bets by getting more and more pot committed into it. It’s a very dangerous and weird game theory playing out there sometimes.
Bill: My strategy has been to do exactly the opposite. [crosstalk] Yeah, and the reason– and I’m not folding permanently at all. I will watch this thing like a hawk because I still believe that if they commit to the long term, and we’ll just see, but I do think the stock is too cheap. I also think it is arguably untouchable right now. But I’ve seen too many people blow up by buying down into positions that they think are getting cheaper and cheaper to do that to myself. I’d rather just– the bet was laid and I’m either going to mismanage the bet or let it play out as it was.
Jake: Yeah, John Hempton has a nice checklist on averaging down that’s interesting. It might be worth checking out if you’re so inclined.
Bill: Yeah, the man The Science of Hitting wrote about not too long ago in his Substack, and Alex and I talk a lot, and I think he’s right. Between what Hempton has said and what Bill Miller is said, which, I don’t remember the letter that Bill Miller said it. But he said that his firm did a study on where they’ve gone wrong, and I’m almost certain it was him. If it wasn’t, I’m sorry, Bill. I know you listen and I know you are super big fan, the feeling’s mutual. I’ve got mad love for you. But they said that they’ve gotten themselves in the most trouble when they think that the stock has declined too far relative to the business expectations, and that in almost every case, it has been a better decision for them to just exit.
Tobias: What’s the main issue for them? They’ve got Fios coming and their DSL twisted pair coax or something like that, and they can’t overbill Fios without spending a whole heap of money?
Bill: Well, no, I think that their main issues is they have a shit shareholder base. If you’re looking at quality shareholder basis, it’s not a quality shareholder basis defined by Lawrence Cunningham.
Tobias: What’s the [crosstalk] in this instance?
Bill: Well, everybody’s addicted to the buyback, because everybody thinks it’s too cheap based on current free cash flow. Well, the cash flow exists arguably, maybe not true, but arguably, because they push price too far, and they’ve cut costs too deeply. They’ve now arguably cut to the bone, and you’ve got to potentially shrink your margins while investing in a Capex cycle, and if you have a bunch of hedge funds that sell because all of a sudden, the story changed, and you might take it under, your shareholder base matters a ton. Because then all of a sudden, you’re not making a business but you’re making a stock bet in my opinion.
Tobias: Good comment here from Arthur Watkins, Charter filed for bankruptcy when it was overlevered and going through its DOCSIS 3.0 Capex cycle.
Bill: It’s a different situation.
Tobias: What’s the difference?
Jake: Altice is like– if somebody informed wants to tell me that this is a legitimate bankruptcy risk, I’m happy to listen to how but I don’t think that’s the issue. Charter was way more levered, and Altice bonds are not trading in a way that indicate bankruptcy risk is on the table to me, nor do I actually think it is.
Tobias: What do you think the take-under happens at 30 bucks?
Bill: I don’t know, man. The lower the stock goes, the lower the take-under. That’s the problem. If the shareholders turn over, you need a vote from the shareholders. If the new shareholders bought at $20, what do they care about the people that bought at $33, or $35, or $40 or any of this?
Tobias: Are there any big minority shareholders or are there any smart minority shareholders?
Bill: Well, the guy that controls it controls it. So, yeah, you’re in a bad situation, potentially. Now, how bad is it? I don’t know all find out together. But I can tell you that the ride has not been particularly fun, regardless of the outcome.
Jake: Stay tuned.
Bill: Yeah. I don’t think there’s a bankruptcy story. I think if somebody has done a lot of work and wants to have that conversation, I’m happy to have it. But I don’t think that’s an informed comment. No offense to the people that listens– [crosstalk]
Tobias: He was asking a question.
Tobias: I might read it in a different way.
Bill: Yeah, no, I think we’ll see. It just sucks, because everything that they said, I actually agree with, like going out and investing in your southern link footprint. Even if they went out and they paid people more, and they got employee morale up, and they even gave people a little bit of a consumer benefit by not raping them on the rack rates, all of that, I would argue, improves terminal value if you’re truly driving the business in the right way.
But your terminal value might come in six months or nine months, and I think management has every single incentive to potentially sandbag all of the communications until then, and that sucks. That goes to, do you believe these are good people, and can you do a good deal with people with bad incentives? So, it’s been an interesting learning experience, probably one of the most valuable ones that I’ve had over the last three years. Absolutely terrible, but I think I will probably remember this one much more than any other one other than my beloved Qurate.
Bill: You’re updating your checklist with all these newfound items that you’re learning?
Bill: I don’t know, man. Go into the Journalytic– look, it’s unclear to me that the bet was bad. I think that [unintelligible 00:19:51] Capital has asked me a question on ideas like this where he has said that he doesn’t like these kinds of bets, because even if the best is not bad, there’s a potential to mismanage the bet. There’s a real possibility that I mismanage the bet as opposed to the bet being bad. So, it’s like what’s– Yes, thus far, it’s been a complete disaster. There’s no hiding from that. So, we’ll see how it all turns out.
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