In their latest episode of the VALUE: After Hours Podcast, Tobias Carlisle, Jake Taylor, and George Livadis discuss:
- Nvidia: The Company That Sucked All the Oxygen Out of the Market
- Why Mid-Caps Offer the Sweet Spot for Investors
- From Internet Backbone to Bankruptcy: The Cautionary Tale of Nortel
- Finding Long-Term Winners in Packaging and Exchange Stocks
- Hedging International Exposure with Defense Stocks
- Coca-Cola Bottlers: How Corporate Governance Can Shape Long-Term Success
- Equity Shorting vs. Puts and Position Sizing
- A Defensive Strategy That Excels in Bear Markets
- Market Signals: What Do Falling Trading Volumes Mean for Exchanges?
- Upslope Capital: A Global Long-Short Hedge Fund Targeting Mid-Caps and Low Volatility Returns
- Beyond SPACs: What Investors Can Learn About Fraud and Fad Shorts in a Bubble
- Tattooed Chef and Beyond: Shorting ‘Uninspiring’ Stocks
- Volatility Laundering in Private Equity
- How to Invest Against the Hype: The Case for Psychological Shorts
- Should You Invest in Home Builders?
You can find out more about the VALUE: After Hours Podcast here – VALUE: After Hours Podcast. You can also listen to the podcast on your favorite podcast platforms here:
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Transcript
Tobias: All right. We are live. This is Value: After Hours. I’m Tobias Carlisle. Joined as always by my cohost, Jake Taylor. Our special guest today is George Livadas of Upslope Capital. How are you, George?
George: Good. How are you guys doing?
Jake: Welcome.
George: Thank you.
Tobias: I’ve known George through his Twitter account for quite a few years. Always enjoy what George puts out on that Twitter account. But George, just for folks who don’t know you, what’s your background, and where are you based, and what’s the fund about and so on?
George: Yeah. So, I’m based in Denver. I’ve moved here about nine years ago. My background, like a lot of folks, I started out as a banker. The first half of my career was more investment banking. Was definitely a late bloomer to the investing world and the buy side.
I always think of the one moment for me that got me hooked. And frankly, it took a little while to even realize that I’d been hooked, but it got me, which I went to business school during the financial crisis, and was just investing my own account and had no clue what I was doing, but I knew it was a lot of fun and really just fascinating trying to preserve and make money during a crazy time.
Like I said, it took me a few years to realize that that’s what I wanted to do as a career. And so, I did some banking after that for a few years covering financial institutions, and then I eventually made the jump to sell side research where I covered the packaging sector for a little bit and then moved out to Denver here, where I made my way to the buy side and then started my own firm called Upslope Capital. Yeah.
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Upslope Capital: A Global Long-Short Hedge Fund Targeting Mid-Caps and Low Volatility Returns
Tobias: What’s the focus at Upslope? How do you talk about your strategy?
George: Yeah. It’s a classic long-short equity hedge fund. So, its global. So, I’d say at any given point, a third or maybe half of the portfolio is non-US. Mostly, it’s a developed market, so mostly western and northern Europe. Mostly mid-cap focused, but I’ve got some leeway to go up and down above that, but I like the bullseye to be on mid-caps.
I think in general, the goal of the strategy is to deliver equity like returns with much lower volatility or much lower market risk. So, pretty uncorrelated with traditional long only indexes.
Tobias: Have you shorted foreign companies? Do you short in Europe?
George: Not as much as I probably should–
[laughter]George: But yeah, I have some European shorts and have shorted some of them. But in general, I’d say, it’s a good question, because like I said, I should probably be a little more balanced than I have been over time. I do have some, but just not that many.
Tobias: How do you think about shorting? There’s two questions there. One is, how do you identify something that you think is a worthwhile short? And then, the second question is, how do you structure it, particularly when– The reason I asked for the European ones, I was just wondering, the time zone overlap might create a problem. I was just wondering how you think through those issues.
George: Yeah. Well, honestly, the time zone scares me a little bit, because I’m one of those people– I know it’s popular in certain value investing circles to not be interested in looking at your screen too much. I’m the opposite. I’m extremely interested in looking at my screen during market hours, and so I do have some paranoia about– I obviously need to sleep sometimes. So, some paranoia about European shorts for that reason.
In general, I think I put shorts into a bunch of different categories and try to have some diversity. You have classic cyclical type shorts. So, maybe a boring company that you think is over earning and hopefully overvalued at the same time have fraud and fad type shorts.
I’d say, my strategy there really evolved and developed a lot during 2020 and the SPAC bubble. So, I launched the strategy in 2017. Before that I’d really shied away from broad type shorts. I just didn’t think they were worth the time, but then the SPAC bubble came around and it was just this fire hose of potential shorts and there were so many that were so obvious and–
They definitely had to do some trial and error with figuring out how to do it, but developed a way to do it and manage the risk around those. I think those are the main categories of shorts though. I think– [crosstalk]
Jake: Not valuation only?
George: I try not to. I’d be lying if I said never. There are definitely some cases where I think a small valuation, only short is okay, but generally try not to. I think I’m more willing to do it when I think it correlates well with one of my longs in the portfolio. So, it’s not just valuation. It’s valuation and there’s a fit with the rest of the portfolio.
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Equity Shorting vs. Puts and Position Sizing
Tobias: Do you short the equity or are you buying puts? If you’re shorting the equity, how do you think about sizing?
George: Well, I’d say 90 plus percent of the time, it’s just short the equity. Sizing depends really just on my assessment of what I think of the upside risk. So, like a large cap compounder that for whatever reason, I think is a short, boring business, large cap, very little takeout value. I’m comfortable sizing something like that up to 3%, 4%, maybe even 5% for the right situation.
For a fraud and fad short, those are more typically, I’d say, 50 to 70 basis points. I try to keep them around that 70-basis point level. A random number, but through a lot of pain and suffering and trial and error, I’ve settled in on that as a good spot.
Tobias: When you say you keep it around 70-basis points, you’re trimming if it’s running against you and it’s getting bigger than that, just trimming regularly?
George: Yeah. If it’s just squeezed and I’m concerned about it for whatever reason, I’ll trim it back to 70-basis points if I need to. Try not to, but sometimes some of them can be a little scary.
Tobias: What’s your net and gross look like over time?
George: So, my gross exposure has changed over time. I think one of my mistakes that I’ve slowly corrected is starting out with gross exposure that was too low. So, in the early years, I had gross exposure around 100 plus percent. And then, the middle of the timeframe, moved more to 125. And then, the last couple of years, I’ve moved it pretty deliberately to 150.
I think it was too low considering that my net exposure, at least my effective net exposure was also low. So, I think my typical net exposure is really 35%, 40%. I think 100% gross with 35%, 40% net, it’s a tough way to actually deliver real absolute returns. And so, I’ve moved it up. I think I’ve been going on a couple of years now, almost maybe a year and a half now at 150. But so far so good.
Tobias: And net’s like 100 at 150?
George: No. So, net is still around– So, when I talk about net, I talk about beta and delta adjusted. So, it adjusted for if I have any options. And in general, my shorts tend to be much higher beta than my longs. And so, beta adjusted net exposure is still around 40%. So, I expanded both sides of the portfolio.
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A Defensive Strategy That Excels in Bear Markets
Tobias: So, how does that perform when you get– We’ve had like a 30% plus run and S&P 500 over the last 12 months. Bigger end of town is doing very well, smaller end of town struggling a little bit. How would you expect to do over a period like that?
George: In general, I’d expect to lag pretty sharply. For portfolio construction, one of the thoughts I always have in the back of my head is what kind of market environment am I most afraid of right now given what the portfolio looks like? Most of the time that environment looks a lot like a market going up 35% in a year. The 2020s SPAC bubble or COVID bubble, whatever you want to call it, that was a pretty tough time to be managing it.
So, in 2021, I was just happy to be up. In general, I’d say expect to lag a lot in the up markets and really outperform a lot in down or flat markets. I’ve been fortunate, the last year has been pretty good for the portfolio. But in general, I think just given the net exposure, I think up markets tend to be much tougher than down markets.
Jake: Well, it’s in the name, hedge fund. It’s supposed to be hedged, right?
George: Yeah.
Jake: It’s not just super long fund. [Tobias laughs] That’s not what they call it.
George: Yeah. In general, I try to have the mindset that I’m happy as long as I’m delivering on the downside protection and the up markets will take care of itself, because I am always– My style bias is super defensive. So, even though I’m always net long, the portfolio does tend to do pretty well when markets are having trouble despite being net long.
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Beyond SPACs: What Investors Can Learn About Fraud and Fad Shorts in a Bubble
Tobias: What did you learn from 2020?
George: I think really it was the 2020 and 2021– [crosstalk]
Tobias: Yeah.
Jake: Have we named that bubble yet, or we just have to wait [crosstalk]?
George: I thought it was the SPAC or COVID bubble. Probably, SPAC bubble. It’s less traumatizing to think about.
Tobias: But then, it sort of went into other areas too, which goes-
Jake: It was everywhere. Yeah.
George: Oh, yeah.
Tobias: -Beyond Meat and Peloton and all that nonsense was crazy through then.
Jake: Car vending machines.
George: Yeah.
Tobias: Well, it’s come back.
Jake: I know.
Tobias: Let’s get it back, baby.
Jake: It is back.
Tobias: Sorry George. Keep going.
Jake: Yeah. [laughs]
George: Like I said before, I think I learned how to manage really the higher short interest shorts and construct a portfolio with those. And so, I remember, I think coming into January 2021, I had a basket of SPAC shorts. I think they were all– This might not sound that crazy, but they were all like sized at 1% each and just got absolutely run over by them. I had thought that, “Okay, a 1% position, how bad could that hurt?” And then, you saw, I like–
I was never short. The real meme stocks like GameStop or AMC, but– I assure you, a 1% short that really squeezes can hurt a lot. So, it made me realize that whatever you think is a small position size for a fraud or fad short, you should be smaller, almost certainly. Like I said, I settled in at like 70-basis points, but since then, I’ve still grinded those down even a little bit further.
Tobias: Yeah. Sizing? That’s hard. I just like to keep them small. I don’t do it anymore, but I always like them small. But I thought that 1% was small.
Jake: Well, it starts small, and then it gets big on you and then you– [laughs]
Tobias: Yeah. Go and trim it.
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Tattooed Chef and Beyond: Shorting ‘Uninspiring’ Stocks
George: So, part of it, it’s not scientific, but part of the thing behind 70-basis points is, if I wake up and it goes up 50%, it just jumps 50%, you can’t do anything about it. It’s now like a 1% position, and I can handle that. Whereas if it’s 1%, goes to 150, then I don’t know, it’s just that much scarier.
Jake: So, was that you were shorting stuff like space or that type of those real science projects in a container of a–
George: Yeah. In general, I think I quickly gravitated towards what I thought were the less sexy, less open-ended type stuff, like the classic one. Most of them did not work this well, but Tattooed Chef, they’re frozen, plant-based foods company. I always thought was just a “fancy” lean cuisine pretty much. To me, I couldn’t imagine people actually getting excited about that, whereas I could see somebody getting excited about the– I forget the–
Jake: Space travel.
George: The space one. But yeah, you can [crosstalk] how people get really excited about those things. So, I tried to avoid those. But you want to, I don’t know, try to focus on the sadder stories. [Jake laughs]
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Why Mid-Caps Offer the Sweet Spot for Investors
Tobias: I feel like no two periods are exactly the same. This is definitely not as memey and as bubbly as it was back then. But I do feel like there’s a lot of similarity in the sense that– I feel like we’re back to Mag Seven being very dominant driving the market. What does the market look like to you?
George: I think that’s right. I don’t know, I’ve been a little bit more in the weeds lately where I try not to pay attention to that. As someone who mostly focuses on mid-caps, I think anybody who doesn’t do large and mega-cap has been irritated by the Mag Seven stocks for a long time. But I think that’s still probably right. They’re still the main game in town.
I think this month, for example, has been pretty rough for European stocks. So, it still feels like the market’s pretty narrow where it’s mega-cap tech US especially versus the rest of the world.
Tobias: What attracts you to mid-cap? Why do you like mid-cap?
George: In some ways, I just defaulted to it. Honestly, when I was a banker– I worked for Bank of Montreal, and we mostly covered mid-cap clients and we mostly covered mid-cap companies when I was on the sell side. And to me, there was a logical opportunity where I think of mid-caps as–
Most companies that make it to mid-cap. They’re probably going to make it, because they’ve made it out of small cap land. So, you’re fishing in a better pond than small and micro caps to begin with. They’re still less well covered than large caps. There’s a lot of interesting companies in the universe. Nothing too scientific, but just seems interesting and there should be opportunity long-term.
Jake: Nice to have professional management.
Tobias: Yeah.
George: Yeah.
Tobias: Ben Claremon pointed out to me that, “The mid cap indexes have the volatility of the large caps and the returns of small caps. So, they have the best risk-adjusted returns,” which makes sense. Like, you can rationalize it backwards if they get escaped small cap land. They’re not yet large caps, so they’re not as well covered, but they’ve got professional management. They’re a little bit better capitalized, and they’ve got more than one product line and they potentially going to get there. And so, it’s a good place to take a bet.
But then, you could make the argument in small that there’s– You’re much more likely to find the things that’ll make it to mid and get the really [crosstalk] chance there.
George: Yeah.
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Finding Long-Term Winners in Packaging and Exchange Stocks
Tobias: So, you don’t want to talk about individual names, but can you give us an idea of where you tend to look, what you tend to look for?
Jake: On the longs side.
George: Yeah.
Tobias: Yeah, on the long side.
George: Oh, longs. Yeah. So, I do a lot in the sectors that I used to cover. I’ve probably done less and less of it over time, but it’s still a core part of the portfolio. So, the packaging sector, I almost always have at least one long.
To me, it’s actually a great universe for long-short investing. So, when I covered it, I covered basically 10 companies. There’s a great diversity of the types of companies within there. You have some, I’d say, more reasonable quality type companies, and then some just tough like melting ice cube situations. There’s a wide range of cyclicality.
And so, to me, there’s always something to do, probably both long and short within the packaging sector. So, it’d be like beverage cans, and glass bottles and plastic packaging, stuff like that. So, I always do something there.
Usually, I have something in the exchange sector, so like NASDAQ, CME, those kind of companies. I covered those when I was a banker. And in that space, I rarely have shorts. I’ve tended to find them– I like the way they fit into a long portfolio. Some of them at least have exposure to volatility. So, as volatility goes up, their business actually benefits.
I think in general, they’re very classic quality businesses. They’re monopolistic in a lot of ways. Depending on the product, really high margin, good cash flows. It can be hard to predict sometimes, but I think that can also be where the opportunity is, because nobody can really predict where trading volumes are going to go, but you do know that over time, they’re going to do okay, and they’ll probably go up over the long run for certain products. And then, beyond that–
Jake: What do they do with the cash? It is always [crosstalk]
George: So, those companies have migrated more towards large cap over time. I think when I started, they looked a little bit more mid-cap like. But I think, Tobias, your comment about professional management, they’re pretty disciplined and pretty professionally managed. So, it’s not something I worry about too much.
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Tobias: What about financials? That was an area that you worked in. Do you own banks or anything like that? Do you look at the banks?
George: Funny enough that, so when I was a banker, I was in the financial institutions group. This always confuses people, but we covered everything except for banks.
Tobias: Ah, okay.
Jake: Oh, yeah.
Tobias: What luck. That’s really luck.
Jake: Dodge that bullet.
George: Actually, I didn’t spend much time– We had an insurance team, but I didn’t really do much insurance, so I mostly focused on market, what we called market structure, so exchanges and brokers, some asset managers. I’ve done some stuff outside of the exchange world, but it’s been in like owning Evercore in the past and things like that.
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Volatility Laundering in Private Equity
Jake: Any thoughts on the big publicly traded private equity firms?
George: No. My bias is I’ve always wanted to dislike them. [Jake chuckles] I’ve been wrong forever.
Tobias: What’s the dislike?
George: It’s the classic, the volatility, the free lunch that they seem to be getting from not having the marks that public equity guys take.
Tobias: Oh, the volatility laundering. I thought you meant, as a business, like the idea that all the assets go down the elevator and leave the building at the end of the day, that kind of.
George: No. So, like I mentioned, I’ve owned Evercore in the past. I think, in general, whenever I’ve owned it, I think people have pushed back on it with that exact point. But I think in general, for the right company, they manage it okay. It’s a risk, but it’s one that I think is pretty manageable as long as the business is in good shape. If the business is in bad shape, then that risk is a real problem.
Tobias: Yeah. I like the asset managers. I think they’re potentially good businesses, but I don’t own any of the private equity ones I tend to own, because these are the ones that are cheap at the moment. There’s lots of value.
George: Yeah.
Tobias: Value managers around that you can get for cheap.
George: Yeah.
Tobias: The risk is that they take themselves private. They go under. They take themselves under, which has happened a few times to me. Pzena was a good one. [crosstalk] absolute steel.
Jake: I do remember that one.
Tobias: You ever look at any of the value managers or the listed equity managers?
George: Have I ever looked at it?
Tobias: Yeah.
George: Yeah. I’ve been short some of them.
Jake: [laughs]
George: Very traditional asset managers. Some of them tend to get pretty crowded, where I find certain shorts can be pretty annoying to manage, where you finally get the earnings call right, and the stock drops 10% and everybody covers all at the same time, because they got their event and they want to move on. The long-term trend is it’s still a melting ice cube. I don’t know, I found them not to be too worthwhile sometimes where it feels not that different than just like a market short because of how correlated they are.
Jake: Yeah. Everyone’s just punting along the way.
George: Yeah.
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Hedging International Exposure with Defense Stocks
Tobias: You’ve factored any macro or anything like that into your considerations?
George: I try not to.
[laughter]Jake: Yeah. Recover.
George: It’s in the back of my head, but I try not to explicitly do it. I’m okay doing factoring in more say, I hate the word, but more thematic type stuff, where I’ve gotten comfortable– I’d say more in recent years of, there’s owning defense stocks in the last few years. I’m not going to just own one of them. I’m actually comfortable owning a handful of them, stuff like that. But I think more like figuring out what the Fed’s going to do and how to position the portfolio, I want not much to do with that.
Tobias: Yeah, because it’s a tough game.
Jake: Yeah. Those defense contractors done pretty well. I know. I looked at it. Gosh, I think it must have been 2019. My thesis was I bought them– I had so much international value exposure. I thought maybe this is a decent hedge for that. If the geopolitical world gets a little rougher, of course, these value names in international are going to get killed. But maybe I could make it up on the other side of being long a bit of human conflict, unfortunately.
Tobias: Could you get both side right?
Jake: No. Only one.
Tobias: But you were right about the value not working. [chuckles]
Jake: Yeah. No. Well, yeah, I was right about that, but I was long that. [laughs]
Tobias: Yeah. You had the psychological short there.
Jake: Uh-huh.
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How to Invest Against the Hype: The Case for Psychological Shorts
Tobias: You got any psychological shorts out there, George?
George: Oh, I have lots of those. Yeah. [chuckles]
Tobias: You prepared to talk about any of your psychological shorts?
George: Probably, all the alternative asset managers [Jake laughs] and the Mag Seven. That’s about it.
Jake: Mm. Just because everyone’s so excited about it?
George: Yeah. It’s okay, I don’t actually dislike the companies. Yeah. I pride myself on having a portfolio that looks pretty different. In my view, you can get exposure to the Mag Seven and that group of stocks pretty easily.
Tobias: There’s an ETF for that.
George: Yup. Lots of them.
Jake: All of them.
George: Yeah. [laughs]
George: Yeah.
Tobias: That’s a good point. Yeah, it’s called spy. Have you heard of it?
Jake: Yes.
George: NASDAQ: QQQ. Any of them. But obviously, they’ve done great.
Jake: ESG and they’re all– [chuckles]
Tobias: No, they’re already crushing it.
Jake: Yeah.
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Tobias: We’re coming up on– Sorry, JT.
Jake: Most importantly though, I wanted to ask George, why did you have Jaromír Jágr in six?
George: So, I’ve played hockey since I was [crosstalk] years old. He was my favorite player. I love his–
Jake: Hair?
George: His hair, his play. [Jake laughs] How he plays and just his demeanor in general, just like a very happy, passionate player. That’s all.
Jake: It seems like he can still play today, huh?
George: I think he does play in-
Jake: Like, some Euro League.
George: -Czech Republic. Yeah. I know he organized a big fundraiser game, I think for Ukraine early on. I can’t remember exactly when that was. I think it was not that long after the war started.
Tobias: Let me do two things. I got to give a shoutout to all the people who dialed in from home. And then, JT, you want to do your veggies at the top of the hour.
Jake: Yes.
Tobias: But give me the 10 minutes or so. It’ll take to run through these days.
Jake: [laughs]
Tobias: Nashville. What’s up? Mendocino. Bellevue. Mac in Valparaiso. What’s up? Brandon, Mississippi. Tomball, Texas. It’s Tyler. He’s our unofficial producer. Toronto. Chapel Hill. Dubai. Tallahassee. Laussane. Am I saying that right? Switzerland. Santo Domingo? What’s up, Danny? Tampa, Florida. I’ve jumped over a few. Colorado. Phoenix. Boise. Jupiter. Andhra Pradesh, India. Hammersmith, London. Breckenridge, Colorado. Someone nearby.
George: Ooh.
Tobias: Tampa, Florida. Hi for Israel. Madeira Island, Portugal. Yeah, I’m going to come join you. Send me the invite. Ballynamullan, Ireland. Good for you. Bangalore, India. Jupiter, Florida. You’ve already one. Pforzheim, Germany?
Jake: Did Bill Brewster make it into the roles? I was-
Tobias: Sugar Land, Texas. Chiang Mai, Thailand.
Jake: -chatting with him this morning. He said he was going to tune in today if he got internet back in Florida.
Tobias: I didn’t see. He’s got to get that– What’s Musk’s– Skylink?
George: Starlink.
Tobias: Starlink.
Jake: Skynet? [laughs]
Tobias: I always forget. Cardiff. What’s up? Last one.
Jake: Oh. [laughs]
Tobias: And now, at the moment that everybody’s been waiting for, JT’s veggies.
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From Internet Backbone to Bankruptcy: The Cautionary Tale of Nortel
Jake: [sighs] All right. Let’s do it. This one might actually fit in with some of the conversation about some of the bigger companies. This is a little story that’s a dramatic rise and fall of one of Canada’s most loved and eventually reviled companies. This company called Nortel. At one point, 75% of North America’s backbone, internet traffic, was traveling through Nortel’s networks.
But let’s rewind the clock a little bit. Alexander Graham Bell, Scottish immigrant, moved to Canada with his family. Supposedly, he wrote the underlying mechanism of the telephone at his parents’ home in Ontario. Eventually, he famously sent that live message to his partner, Watson, while he was in Boston. He always wanted to live in the US. It wasn’t Canada. Yet, somehow Canada still claims that they invented the telephone sometimes. I think there’s a little bit of dispute over that.
So, there was this company, Bell Canada, which was a relative of the behemoth monopoly AT&T had in the US. They had this little branch plant in Montreal where they made telephones. It was called Northern Electric and Manufacturing Limited. There was also this Bell Network Labs, which was a copycat of version of the US’ Bell Labs. So, this is up in Canada as well, BNL. BNL ended up inventing this digital switch, because AT&T really was complacent with their monopoly. They didn’t want to render billions of dollars of their existing equipment obsolete. This is typical innovators dilemma.
BNL was early in commercializing fiber optic cables. At the same time, we had deregulation of the telecom sector, meant that all these companies were racing to get into telephone, cable TV, even this newfangled thing called cellphones. There was this flood of capital into the industry. The digital switching equipment industry was dominated by this company called Lucent, which was actually the new name of Bell Labs when it was spun out of AT&T.
And so, second in line was Nortel, and then third was this startup in Cali called Cisco. So, fast forward, where in 1998. Nortel announced that they’re buying this switching company called Bay Networks for $9.1 billion, which was a lot of money back then. I know now that’s like rounding error, but–
Tobias: Mid-cap.
Jake: Yeah, mid-cap, small-cap. Bay was Cisco’s biggest direct competitor. Except they didn’t use money to buy them, of course. They bought the Bay Networks for shares. So, they created $134 million freshly printed shares. Don’t smudge the ink. This then caused Lucent to buy Ascend Communications for $20 billion. Not to be left out, Cisco went on a buying spree, they bought 64 companies over the next year.
Nortel then went on a shopping spree of their own, buying one company per month. By the year 2000, the Ottawa region had 1,000 companies employing 75,000 people, one in five of them belonging to Nortel. At one point, one in five engineering grads in Canada were hired by Nortel. And if you had a PhD, it was one in three. So, it became this tech corporate Disneyland. Lacks dress codes, no time clock, corporate perks, huge parties every other week. The popularity of Nortel on the Toronto Stock Exchange completely exploded.
In 1998, Nortel shares, they were around 5% of TSE 300. One year later, it was 8%. Three months after that, it was 16%. Nortel’s revenues, meanwhile, were growing all along, mostly through M&A. 26% in 1999 alone. The only other thing they were better at growing was handing out shares. So, they notorious for the stock options. They printed 161 million new shares in the late 1990s. Over a two-year period, they spent $30 billion on M&A, but $22 billion of that was paid for with shares.
The increase in shares came with these restrictions though. So, it would typically be 6 to 18 months where they couldn’t sell. The TSE 300 index, because it was based on a weighting of market cap, they used that number of shares for the allocation, yet the float actually wasn’t really there. So, you ended up with this squeeze that was happening effectively.
So, in 1998, shares out for Nortel were $500 million. Just to give you some context. Within two years, it was like $3 billion. Like, they 6X the share count, which then made the index have to increase their amount. At the height of the dot-com bubble, Nortel finally passed Lucent. And in the summer of 2000, Nortel made up 38% of the entire Toronto stock Exchange.
So, just think about the insanity of that. One company representing 38% of basically Canada. At the time, this was huge. Great news for Canada, who has had a little bit of a chip on their shoulder about being the little brother in the shadow. This really is like the battle of the Bell Labs. In this instance, the Canadian JV team of Bell Labs was beating Claude Shannon’s OG varsity team at that point. That’s the implication of Nortel passing Lucent. At its peak, it was a $400 billion market cap, which today’s dollars was $720 billion, which is actually still pretty good. It was the nineth most valuable company in the world at that time.
Now, here’s where things started going a little off the rails, as you would imagine. They invented their own accounting term, which they called earnings from operations. Now, of course, they still report a gap and everything, but this was one of the early versions of community adjusted EBITDA. [Tobias laughs] They would just basically leave out. It was a lot of pooled accounting, if you guys remember that, some of those things that happened in the late 1990s that eventually was made illegal.
Nortel wasn’t doing anything illegal there. It was just they were aggressive with their accounting. They would highlight the numbers that they wanted to highlight. By the way, comp all the management off of adjusted numbers, not off a gap. So, what’s interesting, of course, is the demand for all this broadband capacity– I’m sure, Toby, you can speak to this from your time, the things that you did in this space, even better than what I’m saying. But it was certainly growing, but just not like the most bullish analyst would predicting.
As those chickens started to come home to roost, like one week in 2000, Nortel crashed, and it fell even that one week from 32% down to 24%. So, when these things have these meteoric rises and they become huge, there’s a lot of space to come down. There were so many shares that were trying to be dumped at the time that the TSE was crashing, several times a day for technical glitches. They just couldn’t process so many people trying to sell. These reports would come out that fiber networks were only being utilized at 7% to maybe 15% of the total capacity. It was just incredible amount of overbuilding.
So, naturally, layoffs start. There’s empty buildings, empty parking lots. They’re selling things for parts. Eventually, it goes down 99% from the July 2000 peak to the October 2002. So, a little two and a half years, you’re pretty much completely wiped out. One-third of their acquisitions were complete write offs, full zeros. Eventually, they sputtered along selling assets. They filed for bankruptcy protection finally in January 14th, 2009.
By the end of the year, they were gone. It took then another 3,000 days for the final bankruptcy proceedings to finish, because it was just this dumpster fire morass of international courts, interested parties, pension plans. Everyone’s fighting over the scraps to carve up what’s left over of this at once was the nineth largest company in the world. The only people who really won this whole thing, the lawyers $1.3 billion in legal fees over that 3,000-day extravaganza. What a– [crosstalk]
Tobias: Good to see the lawyers win.
Jake: Yeah, happy for those guys to get one. So, anyway, we can try to look for lessons in this today. I don’t know, if this has some rhyming with Nvidia. Right now, Nvidia is 7% of the S&P 500 at $3.3-ish trillion market cap. That’s a pretty far away from 38%. Maybe we go there. There’s nothing that says we couldn’t. If that’s the lesson that you want to take away from this history, then I would say–
Tobias: Room to run. Room to run.
Jake: Yeah, there’s lots of room to run.
George: It’s getting started.
Tobias: It’s getting started.
Jake: Just stretching our legs.
George: Yup.
Jake: But I think if things get too extreme– Maybe there’s some other things to look for, is if you see Nvidia start to stretch on making lots of acquisitions, if you see them– maybe the accounting gets a little squishy. There’s lots of these little red flags that can come up and maybe just keep your eyes open along the way or overcapacity comes into the industry in a major way, which would not be the first time that that’s happened in the semi land. So, maybe just little things for you to keep your eye on if you are in long Nvidia.
Tobias: That’s a good one, JT. That’s an incredible fall down 99%.
Jake: Yeah, that hurts.
Tobias: But you couldn’t have shorted it either. It’s one of those ones that you can’t win long or short there.
George: Once it’s down 50%, then you short it.
Tobias: That’s when you short. Yeah. Oh, that’s tough. How do they end up in bankruptcy protection? Telecom must have been making some money through that period, know? Too much debt.
Jake: Too much debt. Just spending money on whatever. It doesn’t matter. Just throwing these fun coupons around that were shares. Just insane. Everyone wanting to get there as fast as possible. When you’re moving as fast as possible, you don’t worry about expenses.
===
Tobias: I got a question for you, guys. I think all of the Magnificent Seven are pretty magnificent, but which is the most fragile of the Seven? We should probably figure out what the Seven are. I’m guessing it’s like Microsoft, Google, Facebook, I mean, Meta. Is Netflix still the N or is Nvidia the N? Apple?
Jake: Apple, Amazon, Tesla.
George: I’m not saying that’s the answer. I’m saying that’s in there.
Tobias: Is that your answer or is that you just– [crosstalk]
George: Oh, no, I was saying that that’s in there.
Tobias: Yeah.
George: I don’t know, I feel like I know lots of people who are short Apple and constantly angry about it.
Tobias: Yeah, I don’t know. Apple’s a tough one. I don’t know if it’s got quite the same. I don’t know, there are a lot of people who like their Apple devices. Are people cutting back though? iPad’s definitely done. The iPad took off and then has come back to earth.
Jake: Are people that excited about the 16 launch? So, I got one, and I don’t notice hardly any difference from my 12 that I was on before.
Tobias: How old is the 12?
Jake: I don’t know.
Tobias: How many years? Is that–
Jake: More–
George: I think I’m on the 12 and I got it in 2021.
Tobias: That’s pretty recent, I think. I don’t know.
Jake: The camera is better. That’s the only thing I could tell so far. Supposedly– [crosstalk] No, but it’s supposed to be. [laughs]
Tobias: It just read in the specs that it was better.
Jake: Shut up, Toby.
Tobias: It’s already gone from– Weren’t they like retina screens five years ago?
Jake: Yeah. Supposedly, the Apple AI is going to be available at some point. Maybe that changes the game. We’ll see.
Tobias: I forget which phone it was. I think it was the Samsung. Somebody showed that they had this effect where they could zoom in on the moon, and it would show the detail of the moon. And then, they figured out that it was actually AI in the phone, because you could take a light across the room, and zoom in on the light and it would add the detail of the moon onto the light,-
Jake: No.
Tobias: -which clearly wasn’t there. Yeah.
Jake: Smart. So, they just had an overlay for any round circle of light?
===
Nvidia: The Company That Sucked All the Oxygen Out of the Market
Tobias: It must have been. Pretty clever. What about Nvidia? I don’t know much about Nvidia at all. It feels to me a little bit like it came out of nowhere and it just sucked up all the oxygen in the room. It was really only this year/ It’s probably only early February this year when they said, “Our next earnings are going to be out. We’re up 70%,” or something like that, projecting like they’re going to double.
George: Yeah. It definitely feels like days where it’s up a lot, the rest of the market is down and vice versa.
Tobias: What does that say to you? Is that short covering or something like that? I don’t know. Or, just all the money in the room?
George: I don’t know. I think the phrase you used I think is probably right where it just sucks all the oxygen out. Everybody’s focused on it. But I don’t know, it’s not my world to–
Tobias: Yeah. Mine either. I just sort of look at them with envy.
Jake: It’s a podcast. You’re free to speculate them.
Tobias: Could have just bought the Mag Seven and headed to the beach.
Jake: Well, it is an interesting– We’ve talked about this a little bit before, but it feels like there’s an element of double counting when it comes to– Nvidia’s revenues are Facebook, Amazon.
Tobias: Are depreciated-
Jake: -their CapEx.
Tobias: -in other people’s books. Yeah.
Jake and George: Yeah.
Jake: We’re spreading out their CapEx over, I don’t know, whatever, seven years is the useful life for some of this equipment. And so, you take 1/7th of the hit for your earnings, but you recognize all the revenue for one of the companies. So, if you blend them all together, it feels like you’re not fully counting everything. I don’t know.
===
Should You Invest in Home Builders?
Tobias: What do you think about the home builders, George? You want to get drawn there?
George: Probably not.
Jake: [laughs]
George: I haven’t really covered home builders specifically. Mostly been short. I’ve been long sometimes, but building products companies, but never builders themselves. I don’t know, I’ve been wary of housing for a while, mostly wrong, I think. But I’d say, it’s one of those cyclicals that I tend to keep an eye on as– I think became a pretty consensus long for a while. I wouldn’t describe it as at least that. My impression isn’t that housing is a consensus long these days, but probably not something I want to own myself either.
Tobias: Yeah. I think everybody got caught– I think when lumber ran, that beat up all the home builders. And then, when interest rates went up and new houses [crosstalk]
Jake: Were [crosstalk] game in town?
===
Where Are the Big Shorts?
Tobias: Yeah, like that no premium or they could buy down the rates that caught everybody offside, I think, and it ran like that. So, it went from undervalued to reasonably valued to overvalued.
George: I think the question on rates is just above my pay grade. I think a lot of people, I would have guessed that rates going way up would have crushed the housing market and things. Obviously, transactions fell, but market seems fine.
Tobias: [crosstalk] either.
George: I’ve assumed that once rates come back down, it might have the opposite effect where it unfreezes some of the pent-up sales. But I have no idea if that will actually happen. It sounds like a nice theory or a reasonable theory. But like I said, just no idea, if it’ll actually work out.
Tobias: The Fed drops, whatever the main rate, they drop at 50 basis points and then-
Jake: How many time?
Tobias: -10-year rallies. The 10-year goes up 50 basis points. Strange.
Jake: It’s bond vigilantes, Toby.
Tobias: Bond vigilantes. Yeah.
Jake: I don’t know.
Tobias: Yeah. [crosstalk]
Jake: We don’t have those anymore, do we?
George: Only some– [crosstalk]
Tobias: I hear about them.
[laughter]George: Like, once a month.
Jake: Yeah. Imagine, like, where’s the Soros character that’s ready, breaking the guilt back in?
Tobias: The big-short. Where’s the big-short?
Jake: Yeah.
Tobias: What’s your conspiracy theory for the big-short, George? Where’s the big-short lurking?
George: I don’t know if I have one right now. I’ve been worried about geopolitical stuff for a long time. It’s not exactly like an out of consensus, out of the blue idea. I think I’m concerned about China and geopolitical stuff for a while. I think other than that, I don’t know that I have any great conspiracy theories.
Jake: Toby, what’s yours?
Tobias: I haven’t read any really good ones. I do love a conspiracy theory.
Jake: You do love a good conspiracy theory.
Tobias: To be fair–
George: The alternative managers, that could be a good one.
Tobias: You mean they get rid of the volatility laundering?
George: Actually, there’s a little bit of a conspiracy theory there, which is the question about why there are no IPOs or why IPOs have been so low, given we’ve had a ripping market and what that might mean for private equity marks. But again, not my world exactly. So, I could be totally wrong there.
Jake: What’s theory on why a dearth of IPOs?
George: I think the theory is that the marks are too high. So, nobody’s willing to–
Jake: Ah, come show your dearth in laundering in public.
George: Yeah. Because the price, then they have to remark them or they’re not where they want them to be.
Jake: Yeah.
George: They with a T, obviously.
Jake: Yeah, those bastards. [Tobias laughs] It’s always them. There is an interesting dynamic of thinking about some of the really big pools of capital that have taken a lot of their active managers down, and then indexed them in place which each person standing on their tippy toes in the parade makes sense to see it better, like, why pay for an index and then also active management fees on top of it? Fair enough.
But then, when you have a private book that you want to unload and get liquidity from, there’s nowhere to put that stuff, because the IPOs are down, there’s no active managers to buy these, whether it’s a VC company being going public or spinning out a buyout back into the public world. Just the appetite isn’t there. So, you cut your nose off a little bit as a big pool of capital, because you took away all the natural buyers from your private side of your book.
George: Yeah.
Tobias: I saw a chart today that showed that cash on cash from private equity is way down and also that they tend to recirculate the companies inside. Once something goes into private equity, it might leave a fund, but it doesn’t ever leave the private equity orbit. It just gets passed hand to hand.
Jake: They’re all going to make operational improvements to–
Tobias: I know some people who have been in companies that have been acquired by private equity. It doesn’t sound very nice. They just tell everybody to cut the budget 30%.
Jake: That’s it? Just red line at the top?
Tobias: That’s the operational improvement-
Jake: Oh.
George: Oh.
Tobias: -which then I guess you relist with a higher multiple, pays for itself somehow, and then that’s some other guy’s problem down the road.
Jake: Yeah.
Tobias: Cut too much muscle.
Jake: No R&D. Yeah. Nothing to create tomorrow’s cash flows.
Tobias: It does seem like there’s a lot of private equity out there. Private equity seems to own everything. There’s been a very large reduction in the number of public companies. The Russell– Not the Russell. The Wilshire 5000 is not 5000 companies.
Jake: What? It’s like 200 now? I don’t know. Oh, it’s–
Tobias: It’s 501? It’s 7.
George: Has it stabilized in recent years? I feel like it was a while ago, I used to see charts pretty regularly of the number of public companies going down, but I haven’t heard much about that lately. Do you know?
Tobias: I don’t, but maybe the SPAC boom brought some more in. That’s the problem that they make the space.
George: They brought them in and then it took them out again.
===
Market Signals: What Do Falling Trading Volumes Mean for Exchanges?
Jake: I will be curious to see– One of the ways that you won in the 2011 to 2021 time period was that total shares outstanding just kept going down, because you had leverage at the corporate level to then do buybacks. There was LBO that was happening over a decade. That gave you– What was it? I want to say it was like a couple extra percent a year compounded return by just lowering the denominator.
But what happens, you get on the other side of that and you see some of these companies like– I think maybe Boeing recently, if I remember right. They’re issuing equity again, because they need to sure up balance sheets. All these things could be going in reverse, and you start adding numbers to the denominator, what does that do for S&P 500 EPS? It can’t help.
So, a lot of these things that we levers we pulled the last decade, just not sure how you could pull those same levers again. Maybe some of them, you have to push the other direction for a while, just not to be a wet blanket.
Tobias: What are some models, George, that you like? Do you like good cash flow, no growth, buying back stock? Do you have any littles-
Jake: Patterns.
Tobias: Yeah, patterns like that that you’re looking for?
George: Not specifically. The way I think about the long portfolio is I have two categories. I’ve got core positions, which are really compounder types, and then tactical, which are more value type, traditional value. There’s some hair on it. It’s obviously cheap. It’s probably cyclical. So, it depends on the category.
For the more compounder type stuff, I think I want to see a very obvious secular growth. For me, the types of companies I play in, I skew more towards being a value investor than a classic growth investor. So, to me, secular growth is GDP plus growth. So, maybe mid-to-high single digit growth or better, regardless of what the economy is doing.
I think some of the exchanges I’ve always found interesting, because some of them focus on products, where there’s an increasing usage of those products. Not just traditional equities, but options or futures or things like that. So, where there’s an actual tailwind. Yeah, nothing too specific in terms of models.
Tobias: The exchanges ever see those volumes going down?
George: They do. Yeah.
Tobias: After 2000 or after 2020, 2021?
George: Yeah, I think you can have– I describe a lot of them as defensive until they’re nothing. So, leading into March 2020, I think some of them performed pretty well, right up until the end, because they were benefiting from the volatility. And then, all of a sudden, there’s this big washout, and it can take a while for them to recover.
I think Cboe themselves, actually– I think they had a bunch of customers, like larger customers. I don’t know if they actually went bankrupt or what, or there’s a big washout and naturally there’s a big drop in trading volumes for a while that takes time to rebuild.
But I’d say, one of the market signals I look at is when I– If the market is in a correction and exchanges have held up, I always think of– When was it? December 2018. I think I’ve got the right month. Market was going down a lot, and then it was like Christmas Eve, like it had this huge rebound. I remember that day, the exchanges all got absolutely smoked. Like, all of them were down.
They’re pretty defensive businesses. For them to all be down like 5% in a day. Ever since then, I’ve always looked to them as, “Okay, if the market’s been correcting for a while, and then all of a sudden, you wake up one day and the exchanges are all smoked, you’re probably at the very last leg of that correction, because that’s the last thing people are going to sell.”
Tobias: That’s the last door that the Grim Reaper knocks on.
George: Yeah.
Jake: [laughs]
Tobias: And once that’s done, they’re all done.
George: Yeah. Then you’re all clear.
Jake: Interesting.
===
Tobias: I got a question from Dimitrios Koutsoumpos. He says, “Any Greek stocks? I don’t know if possible ancestry has made you look at it?” You might have to come clean, George.
Jake: Uh-oh.
George: No, I am half-Greek, but unfortunately don’t have any Greek stocks. I should, but not yet.
Tobias: Do you know anything about private credit?
George: Not really. Yeah, I think of it like the private equity stuff, but maybe I shouldn’t.
Jake: Well, they’re having a lot of conferences about it now, so it must be good.
George: Yeah.
Tobias: It seems to be very hot. It’s very hot one hand, and then there’s a lot of conspiracy theories on the other. But I don’t know anything about either side, so I don’t know.
Jake: Don’t let that–
George: It’s a natural psychological short for me, but I don’t know that’s based on anything.
Jake: [laughs]
Tobias: Yeah, I feel the same way. [chuckles] I don’t really know anything about it, but I’m a [unintelligible 00:55:44].
George: Yeah. I don’t like it.
Tobias: Have you ever done any activist shorting?
===
Coca-Cola Bottlers: How Corporate Governance Can Shape Long-Term Success
George: A tiny bit. I wrote a report on– So, Coca Cola consolidated. It’s a Coke bottler. That was a while ago now. And then, a company called Focus Financial, and then, a company called Sealed Air.
Tobias: How did they go?
George: Okay. Coke long-term, the stock has done unbelievably well. So, it’s not the regular Coke, but the bottler Coke.
Tobias: The ticker is C-O-K-E? That’s the–
George: Yeah. I think that one went well. They’ve managed the business really well. It’s an extremely quirky business. Being generous, using the word quirky. There are a ton of still today, corporate governance red flags, but financially, they’ve done really well. And so, that makes sense.
Jake: It’s all the matters–
George: Yeah.
Jake: How was the return on brain damage from the little bit of activism?
George: It was fine. I think activist shorts probably make more sense for– The companies I focused on were not broad, so they’re just sketchy and overvalued. I think it makes more sense to do activist shorting for probably more like outright frauds or where there’s really some real revelation like that.
For me, that would not be something I would want to do, because I think the sketchier the company, the more likely they’re going to sue you. You’ll know that you’re right when they do that, but it’ll not be a good time.
Jake: Do you agree with Jim Chanos that he thinks this is– Well, I guess I’m not sure if he still thinks this, but he said it a few years ago that it’s a golden age for fraud right now.
George: I’d say it feels a little bit like that, probably more so in 2021. It feels a little bit like that now where I think companies can do whatever they want. You won’t find anybody more cynical on the odds of regulators actually doing something for a fraud short. Most short sellers will say they’re more likely to go after the shorts than the actual company.
Jake: Right.
Tobias: It does seem that way.
Jake: Yeah.
===
Tobias: George, with just a minute to go. In terms of what we see next to the markets, any thoughts on what through to the end of the year? Too close.
George: The thing I keep–
Tobias: It’s just an election in between. So, don’t– [crosstalk]
Jake: So, yeah, there’s nothing really going on between– [chuckles]
George: So, I keep thinking about the last time Trump was elected– When Trump got elected, what happened to small caps. As managing a long-short strategy through that, it was not fun. Being short, lots of sketchy, smaller companies. So, I think that’s probably something that’s in the back of a lot of people’s minds is like, “Not calling the election in either way, but what if he’s reelected and there’s a replay of this small-cap explosion.” So, it wouldn’t surprise me if people are positioning or positioned for that in advance.
Tobias: I’ve seen evidence that they’re positioning for– [crosstalk]
Jake: None of yours, Toby. [laughs]
Tobias: I would love it if they did. I’ll let everybody know.
Jake: Small-caps for sale.
Tobias: There are a few.
George: I don’t know. That’s the only thing I keep thinking about is, is there going to be a replay? People like short sellers, are they afraid of a replay? Who knows?
Jake: What was the thesis? Do you remember what people were saying at that time? Why small caps attracted lower taxes?
George: I think it was tax cuts. Yeah, because they’re more domestic focused.
Jake: Yeah. He’s a low rates guy.
George: Yeah.
Tobias: We all are, these days.
Jake: Yeah.
Tobias: There’s no other way out.
Jake: You look for the high rates guy, that’s just like a skeleton in the closet with cobwebs on it.
Tobias: George, that’s what we got time for today. But if folks want to get in contact with you or follow along with what you’re doing, what’s the best way to do that?
George: Yeah. So, my website has a contact form. That’s just upslopecapital.com. And then, I’m also on Twitter at @upslopecapital.
Tobias: George Livadas, Upslope Capital, thank you very much.
Jake: Thanks, George.
George: Thank you, guys.
Tobias: Thanks, JT. We’ll see everybody next week, same bat time, same bat channel. See you then.
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