Notes on Dead Companies Walking, by Scott Fearon

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On failure:

•  “What I didn’t realize at the time was that living through that bust [oil in Texas, mid-1980s] was the luckiest thing that would ever happen to me. It taught me perhaps the single most important lesson about business and about life: Things go wrong more often than they go right.”
• “[N]o one talks about the real reason the Valley is such fertile ground: failure. It’s the biggest, most volatile Petri dish of raw capitalism on the planet.”
• “But if you’re not brutally honest with yourself about your own potential for failure, you’re going to have a problem—and you’re going to lose money, maybe a lot of money.”
• “Believing that you can’t fail is one of the best ways to do just that.”

Characteristics of bad businesses:

• Most companies that enter bankruptcy are “just plain old failures, the result of bad ideas, bad management, or a combination of the two.”
• In failure shorts, mgmt misstepped by:
  • Learning only from the recent past.
  • Relying too heavily on a formula for success.
  • Misreading or alienating their customers.
  • Falling victim to a mania.
  • Failing to adapt to tectonic shifts in their industries.
  • Being physically or emotionally removed from their companies’ operations.
• These executives are mostly intelligent, honest, and hard-working.
  • But even when management acts in good faith, they have inherent biases: their financial security depends on their business turning around.
    • “People in management positions, even very senior management positions, are often completely wrong about the fortunes of their companies.”
• “Over the years, I have learned to watch out for the word ‘synergies’ when two troubled businesses combine.”
  • “[A]ll of the synergy in the world cannot replace the lifeblood of any business: growing revenues.”
• “Understandably, not many executives are willing to close thousands of their stores and lay off tens of thousands of their employees, even if that is the only way to keep a company in business… most choose more hopeful, less draconian tactics. But in my experience, half measures almost always hasten rather than delay the end.”
• “Ironically, I’ve found that one of the main ways corporate leaders can harm their business is by worrying about its stock too much, either by blaming external factors like short-sellers for its underperformance or by basing strategic decisions on how Wall Street will react to them.”

On tough investment calls:

• “Over the years, I’ve found that doing nothing is often the soundest investment strategy.”

Other insights:

• On adjusting to new realities: “It’s okay to be wrong; it’s not okay to stay wrong.”
• “Failure terrifies people. They’ll do whatever they have to do to downplay it, wish it away, and just plain pretend it doesn’t exist.”
• On the American disposition: “The idea of quitting or giving up is almost unpatriotic. This attitude benefits us in many ways as a nation. But when it comes to business, and also investing this kind of excessive optimism can do more harm than good.”
• Positivity bias in VC and small caps: “They like to think that the little guy will prevail, that the plucky entrepreneur with the novel new product or service will catch fire.”
• Many bankruptcies unfolded within a year or two of mgmt’s enthusiastic urges to buy the stock.
  • These urgings were often accompanied by convincing-looking figures.
• On acquisitions: “[I]ntegrating a separate business into your own is, by its nature, an outside-in process… the seller almost always gets a better deal than the buyer. Sellers know where the bodies are buried in their businesses, and there’s usually a good reason why they’re willing to give up ownership.”
• “The vast majority of corporate leaders spend their energies inventing reasons not to change.”

Historical myopia:

• This is the tendency of humans to use the recent past as the most accurate predictor of the future while paying little attention the more distant past.
• When mgmts make misjudgments about trends, “they almost always err on the side of excessive optimism.”
• The CFO of Global Marine, a Howard Hughes-founded company that leased out offshore drilling rigs and other equipment, pointed to a rig utilization chart and said, “we’ve been in this business for decades, and 70 percent is always the bottom. It never fails.”
  • The utilization rate dropped to 25% and Global Marine went bankrupt a year and a half later.

Fallacy of formulas:

• The author met with Costco and Starbucks mgmts in the same day but passed on investing because their stocks weren’t cheap enough on a PEG basis.
• As a result, he failed to recognize that these were two once-in-a-lifetime stocks that offered consumers affordable but quality goods and small-ticket luxuries, respectively.

Losing your customer:

• JCPenney (ticker: JCP) attempt to go upmarket under ex-Apple CEO Ron Johnson was a notable failure in “firing one’s customers,” since it alienated shoppers from their rationale from going to JCPenney in the first place.
• “[F]or every Steve Jobs, there are countless corporate leaders who have lost everything trying to remake their customers’ habits.”
• Johnson also wanted to make JCPenney into a place where he and his friends could shop, which was a major misstep.
  • Besides eliminating coupons, he curtailed advertising in Spanish, reduced Big & Tall inventory, removed antitheft sensors, and eliminated the ability to pay with cash (which had constituted ~25% of purchases).
• The author made “a little bit of money” shorting the stock.
• In the 1980s, Cadillac began selling cheaper cars, trashing their brand in the process.
• Confirmation bias: “Sometimes management get so emotionally attached to their creations, or so convinced that they’ve discovered a unique market need, that they wind up being the last people on Earth to realize that nobody else shares their opinion.”
• “Investors are also susceptible to this overconfidence. They buy into a company that they themselves patronize, or that they are convinced creates an indispensable product or service, and they often ignore very compelling evidence that the rest of the market does not share their tastes.
• CML Group, the acquirer of the company making the NordicTrack, bet that every American household would want that exercise machine, but the actual interested market turned out to be much smaller.
• CML Group went bankrupt in 1998, less than 10 years after the NordicTrack acquisition.
• Dotcom services such as grocery-delivery service Webvan (and its imitators, like Groceryworks) failed to realize that the bulk of groceries are bought by families.
• Parents place a lot of emphasis on purchasing the right food—it’s almost instinctual.

“Buggy whip syndrome”:

• This phenomenon occurs when a company’s industry has left it behind.
• Blockbuster, below, is one particularly striking example.
• Cable companies focused on marketing landline phones to their consumers in the early 2010s, focusing sales efforts on an obsolescing method of communication.

Out-of-touch or buck-passing mgmt:

• JCPenney CEO Ron Johnson commuted into Plano, Texas from Silicon Valley weekly and stayed at the Dallas Ritz-Carlton on the company’s tab.
  • Mgmt has to be in the trenches: while being out of touch with his customer base was Johnson’s undoing, “his self-imposed distance from his own workers might have been just as corrosive.”
  • The author blames Ackman for Johnson’s hiring.
• Despite some layoffs and office closures, Building Materials Holding Corporation mgmt never gave up the company’s expensive San Francisco headquarters.
• “Almost every business faces some kind of disruptive event in its lifetime, and it’s up to its managers to make sure that it evolves and continues to compete. But when those managers don’t disrupt their own lifestyles to bring the changes about, their efforts are almost always doomed. It’s like trying to lead a cavalry charge from behind. If you’re not willing to take a bullet yourself, you’re not going to inspire many people to follow you into battle.”
• Colorado-based turnaround candidate MiniScribe was run by a Bill Hambrecht-selected fixer who managed from Los Angeles.
  • The manager’s intense style led the company to falsify its results.
• In 2013, Cisco blamed an offshore sales decline on Silicon Valley spying revelations.
  • However, Huawei had been taking share from Cisco long before this news broke.
• One San Antonio-based discount retailer, 50-Off Stores, used the same “bad weather” excuse for poor sales—worded the same way—in their filings two years in a row.
  • The company went bankrupt a few years later.
• Recession-based excuses for bad company performance were also common in the aftermath of 2008.
• Both aggressive internal growth and acquisitions can kill a business if not done carefully.
• In 2010, Hewlett Packard bought Palm, which the author was shorting at the time.
  • By this point, Palm’s market had left it behind, and HP closed the unit and wrote down the bulk of the investment in 2011.
• Acquisitions also have the potential to destroy employee morale if culture doesn’t merge well or the new employees aren’t appreciated.
  • The four major San Francisco-based investment banks were all acquired by large financial institutions, but their core asset—their people—could not be incentivized to stay under new mgmt.

Restaurants:

• Casual fine dining businesses almost always fail if they don’t tweak their concepts over time.
• Franchising mistakes: Krispy Kreme allowed “area developers” to take responsibility for large swathes of territory, rather than forcing the franchisees to prove themselves first.
  • This allowed Krispy Kreme to expand quickly, but it also meant that several of the area developers went bankrupt, taking entire major metropolitan areas “dark” as they did so.
• The author has financed two Cajun restaurants in the Bay Area.
  • The first one was in Marin County, full of “aging flower children” who didn’t like the cuisine, no matter how good the food was.

Prestige:

• Pedigree does not mean success: “I can’t tell you how many times stock analysts and fellow money managers have tried to convince me that a clearly troubled company would turn around simply because its CEO was a graduate of some distinguished school.”
  • “’He’s a Harvard MBA,’ they’ll say in almost reverential tones, or ‘He graduated cum laude from Princeton,’ as if those facts alone would be enough to offset overwhelming evidence that, despite their impressive backgrounds, they were running their businesses straight into the ground.”
• Stanford professor and GSB dean Robert Jaedicke was chair of Enron’s audit committee from 1985 to 2001, among other board seats he held.
• The author avoided investing with Bernie Madoff because, among other reasons, he didn’t meet with potential investors and distributed his performance fee among asset-gatherers who recruited new clients.
  • The affinity effect: Madoff was considered a pillar of the Jewish community.
    • “Even the sharpest, most astute professionals tend to perform less due diligence when they’re dealing with someone with whom they have an affinity.
• Drive, intelligence, and success, though positive qualities, “create negative results when they lead people—and their followers—into overconfidence or hubris.”

Growth vs. value investing:

• TXU had tremendous cash flows, but most of its power generation came from coal, which was rapidly falling out of favor.
  • This led to the disastrous buyout in 2007, which resulted in TXU going bankrupt under a considerable debt load in 2014.
• People who used TGI Friday’s revenue and income growth rates as a yardstick noticed the inflection point at which the “fern bar” fad had begun to decide.
  • On the other hand, value investors who were looking at multiples of cash flow “waited too long to leave the party and got hammered because of it.”
  • This episode solidified the author’s position as a growth, not a value, investor.

Shorted California Coastal Communities (ticker: CALC):

• He missed a meeting with mgmt in 2008 due to fender-bender, but when he took a trip to the company’s only housing development, he noticed it was mostly empty and very crowded, with one (expensive) house beginning right where another ended.
  • Coupled with the company’s falling revenues and rising debt, this field trip was enough to make him short the stock.
• With falling revenues and rising debt, stock went bankrupt in 2009.
  • A lot of “smart” guys will make dumb calls: another money manager bought ~20% of the company while it was in Chapter 11 proceedings, but the equity was wiped out in the final settlement.
  • JMP Securities issued a “strong buy” on the stock two weeks before it went bankrupt.

Shorted Value Merchants (ticker: VLMR):

• The company, which operated dollar stores, was aggressively opening new locations with a stated goal of doubling the store count every year.
• However, a lot of the stores’ chintzy inventory remained unsold.
  • “Where does that stuff go?” he asked the store manager. “To the next store, I guess,” she replied.
  • “It was a kind of inventory Ponzi scheme” where the company was relying on store growth to generate revenue with no money left over to buy new merchandise.
• VLMR filed for bankruptcy within a year of his store visit.

Went long Advanced Marketing Services (ticker: ADMS):

• ADMS distributed books to major retailers.
• The company took only a (fixed) 15% markup and bore the costs of any book returns.
• In order to combat a 25% return rate, the company had opened outlet stores and had begun promoting those books.
  • The promotions brought in additional revenue for the company.
• Despite the company’s revenue growth, it traded at only 10x earnings.
• However, after tripling the author’s initial investment, the stock was sinking due to eroding margins (which never recovered, despite numerous attempted solutions by mgmt).
  • A Fidelity manager who happened to be the cousin of the ADMS CEO also told the author that “I wouldn’t go near that company… it’s a terrible business.”
• The author eventually sold his stake for less than he paid.
• Margins continued to contract before the FBI uncovered lower-level fraud that had led to overstatement of earnings by +20%.
  • While the author stated that it would have been very difficult for him to uncover the fraud, what he should have acted quicker on—and what really killed the business—were the tumbling margins.
• However, ADMS took five years to finally go bankrupt, sustaining multiple rallies in the process.

Shorted Supermedia (ticker: SPMD):

• Supermedia produced yellow pages phonebooks.
• The author did not short Supermedia the first time it went bankrupt, when it was called Idearc (ticker: IAR).
  • To begin with, the company touted its online portal, which structurally failed to compete with Google or any other search engine. “But our bread and butter”, the CEO said, “will always be our traditional books”.
    • When the author protested, the CEO pointed out that residents of states like Kansas or Arizona were much more prone to use tools like the yellow pages rather than the Internet.
    • However, the CEO himself had never lived in such a state.
• Idearc went bankrupt within a year of the meeting.
• Once the company reorganized as Supermedia, another opportunity presented itself.
• Sell-side analysts loved the stock, since it was being run for EBITDA.
• Even though the company’s share price peaked at $45, the author waited until it had fallen to $10 to short.
• After the company went bankrupt, it merged with another yellow pages company and became Dex Media (ticker: DXM), where plenty of people bet on its recovery.

Shorted First Team Sports (ticker: FTSP):

• The long thesis was that rollerblades were here to stay.
  • Sell-side analysts were blind to this because they tended to be high-earning, “trendy”, and very competitive people.
    • One analyst told the author that he would be able to stroll through Golden Gate Park in 10 years’ time and see 10 rollerbladers for every biker.
• The author shorted from a stock price of $6, when it was trading at 30x earnings, down to $2.
  • First Team Sports was bought out at $1.

Shorted Chemtrak (ticker: CMTR):

• Chemtrak made an over-the-counter blood test for cholesterol.
• The CEO, a PhD, opened by saying that peak sales for the blood test would be larger than the five million home pregnancy tests sold every year, since both men and women were concerned about heart health.
• After hearing this apples-to-oranges market estimate, the author instructed one of his employees to mark the boxes containing Chemtrak’s tests at twenty pharmacies around his office.
  • None of the boxes had moved at the end of several months.
• The author shorted the stock at ~$20 and sold when it was below $1.

Observed PlanetRx (ticker: PLRX):

• The company aimed to deliver prescriptions to customers’ homes.
• However, delivery took between 24 and 72 hours.
• The company also drastically overestimated the number of people who wanted prescriptions delivered to their homes in 1999.
  • Senior citizens, who consumed more prescription drugs per capita, were unlikely to want or even know how to use a computer to order, but mgmt insisted, “we’ll teach them.”
• A year after the meeting, the stock had gone from ~$40 (and a billion-plus market cap) to less than $1.

Observed Women.com (ticker: WOMN):

• The company ran a portal focused on women, and it would theoretically make money by selling banner ads, although it had not yet begun doing so.
• “We’re one of only two companies in the country targeting this demographic,” the CEO explained, adding that women were the fastest-growing population of Internet users.
• “[W]hat could go wrong?” “Quite frankly, Mr. Fearon, nothing. We’ve looked at all the data, and we’ve discussed this very issue at the board level and we all agree: there’s just no way we can lose.”
• In 10 months, shares of Women.com went from $15 to $.70.
  • It was very soon bought out by struggling rival iVillage for even less.

Shorted Quokka Sports (ticker: QKKA):

• The company aimed to popularize yacht racing broadcasts, with a key selling point being multiple views from cameras mounted all over each boat.
• “Alan [the CEO, an avid sailer] fired up the iMac on his desk and logged on to Quokka’s website. It showed a sailboat lowering its jib. A couple of other sailboats were behind it. I surmised that they were in some kind of race. But it was hard to be sure. They were hundreds of feet from each other and they looked like they were going about three miles an hour.”
• Quokka had secured the exclusive online rights to broadcasting the America’s Cup in Australia and expected a minimum of two million unique site visitors in America alone, with four million worldwide.
• The company filed for bankruptcy within one year of the mgmt meeting.
• Interestingly, Larry Ellison made a similar bet when encouraging San Francisco to host the Americas Cup in 2013, although he didn’t suffer financially as a result.

Observed Fresh Choice (ticker: SALD):

• The company was a healthy cafeteria chain aimed at families.
• However, they were located mostly in the Bay Area, where health-conscious customers were not likely to want to go to a cafeteria, while all-you-can-eat aficionados were unlikely to want to pay top dollar.
• The founders were Mormon and were likely aiming for an offering that they and their families could enjoy.
• After the stock rose in the wake of Fresh Choice’s aggressive expansion, the company eventually had to downsize and declared bankruptcy.

Observed Cygnus Therapeutics (ticker: CYGN):

• Cygnus was developing a product for diabetics, the GlucoWatch, that would use the wearer’s sweat to determine glucose levels.
• The author visited the company several times beginning in 1995, and in each instance, he was told that the watch was “almost ready”.
  • Mgmt was so confident in the prospects for the watch that they sold the rights to their other products.
• When the author tried a prototype, it failed to produce a reading after 15 minutes of wear.
• The watch finally launched in 2001, but the product was underwhelming and produced faulty readings as well as wrist rashes.
• Cygnus’s mistake was continuing to throw money at the GlucoWatch to the exclusion of any other lines of business.

Shorted Shaman Pharmaceuticals (ticker: SHMN):

• The company was developing pharmaceutical-grade medicines based on the remedies used by indigenous peoples of Brazil.
• The founder pitched it as “the perfect blend of East and West, old and new.”
• The company began in 1989 with plans to cure cancer, HIV, and other disease.
  • In the end, the company produced one treatment: an antidiarrheal from an Amazonian tree, although it failed to get approval until 2013.
    • Interestingly, rights to this drug were acquired by Salix Pharmaceuticals, which was in turn bought by troubled company Valeant Pharmaceuticals.
• Within a year of the author’s 1998 meeting with Shaman, the company filed for bankruptcy.
  • The founder went on to found another, similar company, and then another, spending more than $200 million in all to get the diarrhea drug approved.
  • Shaman is a testament to manias that surround certain industries or practices—in this case, alternative medicine and anti-corporatism.

Observed Prime Motor Inns (ticker: PDQ):

• The company, owner of famous motel chain Howard Johnson’s, among other similar holdings, was buying up competitors in a shrinking revenue pool—and incurring additional debt in the process.
• The company went bankrupt in 1990.
• A short pitch for this stock catalyzed the author’s interest in shorting.

Observed Blockbuster (ticker: BBI):

• In 2007, the video-rental company was trying to reinvent itself by offering movies for sale, concession stand snacks, and other non-video items at its retail stores.
  • This doubling down on a shrinking revenue pool was partially due to a CEO change instituted due to pressure from corporate raider Carl Icahn.
    • The new CEO shuttered Blockbuster’s online service offering, which would have been a competitor to new entrant Netflix.
• The author never shorted Blockbuster due to fear of Icahn’s control over the board, but he shorted 3 other video rental companies that went bankrupt.
• At one point, analysts were excited that Blockbuster would save itself by merging with competitor Hollywood Video, even though ex post, it’s unclear how such a merger would save the flailing companies.
• Blockbuster also contemplated buying Circuit City.
• Blockbuster declared bankruptcy in 2010.
• In the author’s estimate, the company could have been turned around, but it would have required a mgmt heavily invested in gutting the legacy business model.

Shorted PageNet (ticker: PAGE):

• The company was a pager manufacturer.
• In 1999, mgmt tried to convince the author that people would carry both a pager to receive calls and a cell phone to answer them at their leisure, even showing survey data that supported this conclusion.
• The company also cited emerging markets as an expansion opportunity, blind to the fact that cell phone manufacturers with much deeper pockets were targeting the same regions.
• PageNet went bankrupt in 2000.

Shorted Ultimate Electronics (ticker: ULTE):

• Ultimate offered high-end audio and video equipment.
  • However, big-box merchants were offering the same products for less.
  • ULTE stated that its superior customer service would continue to set it apart.
• The company went bankrupt within a year of the meeting.

Went long Texas Air (ticker: CAL):

• The airline, which had just acquired Continental Airlines and gone through a bankruptcy, was run by Frank Lorenzo, a notable corporate raider.
  • Lorenzo had used the bankruptcy to reset employee wages and reduce the number of routes.
    • Since Continental Airlines didn’t have the business traveler base that airlines like American, United, and Pan Am had, it couldn’t get away with charging similarly exorbitant fares.
    • At the same time, low-cost carriers like Southwest were eating into the older airlines’ traveler base.
    • This meant that if Continental hadn’t reorganized, it would have been, in Lorenzo’s words, “the fucking ham in the fucking ham sandwich”—or dead meat.
• The author bought in at $5 a share and over the next 3 years, the stock grew to $50 on the back of rapidly growing earnings from Texas Air’s low-cost focus.
• The share run-up notwithstanding, the author remained wary of Frank Lorenzo’s overriding focus on dealmaking over organic growth.

Shorted Building Materials Holding Corporation (ticker: BMHC):

• BMHC sold construction materials and services to housing developers—a commodity-driven business.
• By the summer of 2007, BMHC’s business had eroded after a record 2006.
  • Construction permits for new homes had fallen -30% YoY, while the company’s net income had decreased by almost -75%.
  • BMHC had rolled up regional builders and was now looking at a cash flow to debt ratio of less than 10%.
  • The CEO assured the author that the housing downturn was near its bottom.
• By late 2009, BMHC was bankrupt.

Shorted Consilium (ticker: CSIM):

• Consilium built factory automation software.
• In 1991, the company’s debt was rising while revenue growth was slowing.
  • Consilium’s CFO tried to blame lackluster sales on the following:
    • “‘It’s very simple Scott,’ he said. ‘It’s all about M-1.’
    • ‘M-1?’ I asked. ‘What do you mean, M-1?’
    • ‘M-1,’ Mark repeated. ‘The aggregated money supply. The Federal Reserve has been constraining it over the last two quarters so factories aren’t spending like they used to. That’s why sales have been flat.’
    • ‘Hold on,’ I said. ‘M-1 is literally trillions of dollars. You guys do like ten million a quarter in sales. You don’t think your problems might have something to do with the quality of your products or what your competitors are doing?’
    • ‘Oh no, absolutely not, Scott,’ he said. ‘We’re rock solid. It’s the Fed. I’m telling you. They’re killing our business.’”
• The author immediately shorted the stock at $17, covering at ~$10 the next year.
  • Consilium was eventually acquired in 1998 for $7 a share.
• One Consilium long who confronted the author at a conference told him that he had put in “hundreds of hours” of research on the stock and was convinced CSIM was a great investment.

Shorted Wilsons Leather (ticker: WLSN):

• Wilsons, a leather retailer, acquired dozens of airport kiosks selling luggage and travel equipment right before September 11, 2001.
• The company went bankrupt as a result of the severe drop in air traffic.

Shorted Dendreon (ticker: DNDN):

• • The company was first to market with a nonsurgical prostate treatment, but the competing products on its heels had comparable efficacy and were much cheaper to administer.
• • The company was also struggling with an expansion-minded debt load accrued at its peak.

Observed Silk Greenhouse (ticker: SGHI):

• Silk Greenhouse sold fake flowers out of bankrupt grocery store locations.
• SGHI was briefly a Wall Street darling.
• When the author visited its rural Florida headquarters in 1989, he was greeted by a welcome sign with his name and, underneath it, the most recent stock price.
• The company was focused on expanding the number of locations aggressively.
  • It filed for bankruptcy by the end of 1990.

Shorted and longed Cost Plus World Market (ticker: CPWM):

• Cost Plus was a discount retailer with a “treasure hunt” feel that also sold Chilean and Australian wines.
• In 2003, mgmt planned to expand to 600 stores from its current 175.
  • At the same time, it planned to sell more high-end furniture and French wines.
• CPWM’s ticket size was growing, but its number of customers was shrinking, leading to slowing comps.
  • Turnover was also down due to a higher proportion of luxury goods.
• The stock price had peaked above $40 a share amid investor euphoria, but by 2007, it was $8.
  • At this point, the author shorted CPWM.
• In 2008, the company promoted a new CFO.
• After bottoming out at $.50 a share, the price began to climb again in 2009.
• The author met with the company again to see if its strategy had changed.
  • To his surprise, the new CFO was frank about admitting past mistakes and stated that the company was returning to its bargain-hunting roots.
  • In fact, the company had already closed stores and cut headcount as part of its “own personal recession”. This meant that Cost Plus was in a position to take advantage of overstretched competitors.
  • CPWM also had a line of credit to tap for financing its recovery.
• The author covered at $3.50 in 2010.
  • At this point, sentiment had reversed: only one sell-side analyst—with an underweight rating—covered the stock.
• After waiting to see the company’s 2010 holiday performance, the author bought in at ~$8.
  • In May 2012, after a string of successful results, the company was bought by Bed Bath & Beyond for $22.

Went long Zale Corporation (ticker: ZLC):

• The company was a jewelry retailer for the middle class that specialized in the bridal market.
• Zale went downmarket, stocking kitschy items like Hello Kitty iPhone cases.
  • At the same time, it invested in aggressive store expansion.
• By 2007, the company had resorted to giving discounts on already-discounted merchandise to clear inventory.
  • As a result, the company’s stock price declined from the mid-$20s to below $1 by 2010.
• By 2011, however, new mgmt was optimistic about the company’s turnaround.
  • They had closed locations and high-graded inventory again, while a term loan and PIPE from Golden Gate Partners provided much-needed cash.
  • Zale also in-housed its loyalty credit card, saving itself the transaction fee.
• Mgmt was committed to creating and marketing high-quality jewelry collections in partnership with designers like Vera Wang, which strengthened its brand.
  • This pushed the author to go long in ZLC 2013 at ~$5.
• Margins grew, as did comps, and the company became profitable again in 2013.
• In 2014, Zale was bought out by Signet for $21 a share.

Went long International Gaming Technology (ticker: IGT):

• IGT was a slot machine company.
• In the early 1990s, IGT’s business was booming, thanks to tremendous growth in Indian casinos.
• The company had weathered previous lean periods, like the mid-1980s, not by chance, but because of an unwavering focus on R&D—and recruiting and retaining top engineering talent—that made their machines must-haves for casinos.
  • Rather than “try to wring a few drops of profit from an ever-shrinking pot of revenues”, IGT sought to create game-changing innovations.
    • The company pioneered the progressive jackpot: linked slot machines, rather than solitary ones, enabled a larger potential payout.
• In addition, a third of IGT’s earnings was from leasing the machines rather than selling them outright, which would allow them to weather future downturns.
• The author bought the company’s stock at ~$35 per share, holding at least through 1997 (but likely much later).
• Despite the fact that gaming was undergoing a renaissance, IGT’s two largest competitors failed to appreciate nearly as much, even though they began at lower valuations.

On the 1980s oil bust:

• Things move fast: “By the end of the 1980s, the ten largest banks in Texas had all either gone under or been gobbled up by larger institutions.”

On the dotcom era:

• “One analyst at Paine Webber tried to talk me out of shorting a money-losing dotcom by repeatedly predicting a price target based on something called its ‘future terminal multiple.’ When I finally asked him what the hell that term even meant, it turned out he had made it up.”
• “We [Oak Investments] studied their proposal and right away we knew there was no way they would turn a profit in a million years. None. It was obvious. I don’t know what kind of math people are using anymore, but it’s not the math I learned in school.”
• “[P]eople fell in love with a story about the internet: that it would magically transform human behavior.”

The author is probably too bearish about tech:

• Since groceries are so low-margin, he thinks that Amazon’s Fresh grocery service will be used as a loss leader, not as a long-term profit center.
• He is skeptical of Snapchat’s refusal of a $3 billion Facebook buyout offer.
  • The company is worth well more today, and it could be argued that it’s one of those “once in a lifetime” investments he talks about—if it can find a way to generate revenue reliably.

His only money-losing year was 2009:

• He failed to predict the government bailouts of banks and other financial institutions.

On the financial services industry:

• Index weighting is misleading to investors: for example, while Apple went from $40 a share in 2005 to $700 a share in 2012—and the NASDAQ went from 2,250 to 3,000—more stocks in the NASDAQ went down than went up.
• Hypercompetitiveness among financial professionals is a “terrible trait for any investor.”
  • However, brokerages and other institutions actively seek out the most competitive people to work for them.
    • In many cases, these candidates are athletes.
  • These bright, cutthroat people are essentially paid top dollar to pitch crappy businesses to potential investors.
• “Excessively competitive people have a hard time accepting” the reality of losing investments. “They overestimate their own abilities and their own chances of success. Worst of all, they are reluctant to give up when things turn bad.”
• He mentions Bandel Carano of Oak Investments as a shrewd VC who saw a lot of the dotcom nonsense.
• “Effective money managers do not go with the flow. They are loners, by and large. They’re not joiners: they’re skeptics, cynics even.”
  • The author offers Warren Buffett’s purchases of shares in asset-light business like Capital Cities and the Washington Post in the 1960s as an example—most contemporary money managers were buying capital expenditure-intensive businesses like US Steel.
  • Good money managers are also “broad-minded and intellectually curious.”
• “[P]ride often goeth before bankruptcy, too. If you’re not willing to admit your own mistakes and misjudgments, you’re going to eat them for lunch.”
• Blaming short-sellers is “a convenient way to justify unwise investments and deflect attention from the real reason companies lose value: the poor decisions of the people running them.”
• The author used to participate in a stock-picking game with 20 other brokerage salesmen and Street analysts.
  • When he mailed them all a book he had enjoyed—In the Shadows of Wall Street, by Paul Strebel—none read beyond the first page.
• The author’s first boss was “not a bad money manager”, but he had “a critical weakness: he thought he had friends on Wall Street.”
  • He bought into several bad spinoffs and stock offerings that brokers sold him on.
• In general, brokerages tend to overpay elite college graduates to “analyze” companies they were underwriting.
• Although the term is no longer used ironically, the phrase “the best and the brightest” actually came from a book about how Ivy League technocrats precipitated US entry into the Vietnam War.
• “I can tell you in no uncertain terms that buying stocks on the word of so-called experts is the single biggest mistake an investor can make.”
  • This advice applies not only to brokers, but to the coltishness attached to gurus.
    • Paradoxically, “the people who actually possess these kinds of insights almost never share them.”
• Most investors are bad because they are particularly subject to groupthink, are hypercompetitive, and worship the rich and powerful.
• “It’s a fixed, if seldom discussed, rule of asset management: Asset size is the enemy of return.”
  • Mutual funds facing declining returns due to asset bloat often simply start a new fund to continue gathering assets.
  • Tiger Management performed worse as it got larger, perhaps even losing more dollars in total than it made.
• The author helped seed a friend’s hedge fund and when he tried to withdraw some funds, he was first rebuffed on a technicality and eventually received the majority of his redemption in highly illiquid “legend shares” that lost almost all value before he could sell them.
• Front-running, or trading on one’s personal account ahead of taking a position for one’s fund, is extremely prevalent in the industry and rarely gets punished.
• A brokerage firm offered the author an opportunity to short a stock that was to announce a private investment in public equity (PIPE).
  • Apparently, this is a common insider trading scheme, in which investors short a stock and then buy the company’s discounted PIPE shares to cover their shorts.
• “[U]nlike the best companies in the private sector, Wall Street often produces products that cannot scale.”

Investing approach specifics:

• The author never buys into IPOs: “unless you are one of the insiders who gets awarded sharply discounted shares, they are almost always terrible investments.”
• The author waits until a stock is trading at least -50% below its 52-week highs before going short.
  • He wants to avoid momentum-chasing and related short squeezes, since those can destroy an otherwise sound short.
• A “winning at all costs” approach can be detrimental to the investor, because “quitting is very important when you’re buying and selling stocks”.
  • When you recognize you’ve misread a stock, you should get out right away.
• “I generally prefer to invest in companies that grow organically, at a reasonable pace.”
• Take Stephen Mandel’s advice: don’t go “Excel crazy” and lose sight of the big picture.
  • One can learn a lot from talking to mgmt.
• On averaging down: if the narrative of the business has changed and the stock has fallen, don’t try to convince yourself that buying more shares for less is a good thing.
  • Many seasoned investors “keep reassuring themselves with this flawed reasoning right up until the day they go broke.”
    • They also resort to scapegoating, “convincing themselves… that external rather than internal factors are causing the companies to struggle.”
  • This logic applies to shorts, too.
  • You should have faith, but don’t have blind faith.
• “Selling a great stock too quickly is the opposite of averaging down, but it is also rooted in people’s fear of failure; they’d rather take a small profit on an investment than risk it going down again.”
  • Peter Lynch referred to these two mistakes as “watering the weeds and cutting out the flowers.”
• Stocks tend to go up gradually, but they fall rapidly.
• The stocks of smaller companies tend to have a higher likelihood of being inefficiently priced.
  • Wrt larger companies that are well covered and studied, “when the microscopes come out, returns get microscopic.”
• Renewable energies (ethanol, hydrogen, solar, etc.) are prone to investment manias.
• “[F]or almost anything more expensive than small luxuries like Starbucks coffee, most Americans shop on one thing and one thing alone: price.”

On shorting as an investment philosophy:

• “[F]ailure in business (and in investing) happens more frequently than success. Acknowledging that fact instead of pretending it isn’t true has helped me make a lot of money. But… Going long on successful businesses will always be the best way to earn outsize returns.”
• “There’s a fixed number between a stock price and zero, and that’s as much as you’re going to get out of those positions. For long investments, however, there is no such limit.”
• Since 2008, shorting has become less profitable:
  • There are fewer IPOs and more private companies.
  • Sarbanes-Oxley has reduced the number of frauds.
  • Borrow is more expensive due to low rates.
  • Short-selling is also a more competitive field than it was.