It’s weird when you listen to someone that you’ve never heard of before—someone that you’ve never met—talk about his opinions on a complex issue and you both are in complete agreement. This is exactly what happens to me every time I hear Roger McNamee talk. We are both bullish on Facebook and Apple; bearish on Google and Microsoft… and for the same reasons.

The final auction for FB shares is this coming Tuesday. Since I have no plans to participate in this last chance round, I think now is a good time to discuss my views on the company and why we have such a large position in it. I think the press in general has done a pretty bad job reporting on Facebook. There appear to be various errors here and there. Also, none of the hedge fund managers I’ve met with in the past year owns any FB, as they stick to their cheap-by-the-numbers approach and buy Google.

Lots of interesting stuff to talk about! I’ll leave you with a picture of Bloomberg’s data on FB, which must be incorrect. Look at the estimates for 2012:

Click on the photo to enlarge it. On the right-side computer monitor, I had my list of longs and shorts arranged carefully under relevant categories. Longs occupy the top half; shorts occupy the bottom. I just went through 40 or so tickers and checked out how they have performed since (the photo is dated February 17, 2011). If most of these tickers look familiar to you, that’s because I was testing out the ideas written up on a certain website that most of you read reports on. I also threw in some of my own ideas here and there, along with Chinese RTO shorts that everybody knew about.

It looks like the Chinese RTO shorts were REALLY amazing trades as a whole. I think HRBN was the only one to survive the deluge. The so-called fad shorts were actually really bad trades, with the exception of the two rare earth stocks. This supports my theory that consumer goods companies should be shorted only after extra scrutiny, or not at all. The cyclical shorts (mostly a list I came up with after listening to Jim Chanos) all dropped a lot. It was a great macro call on his part. (Not sure why LNG is on that list.) Under the regulatory category, GDOT dropped a lot and so did the for-profit education stocks. The rating agencies, though, had a huge rally. I guess it’s not so easy to tell how regulations will move stocks. The Obsolete list is my absolute favorite because it’s mostly comprised of my own ideas. LOGI, RIMM, NOK, EK—all trainwrecks. The outlier was GRMN, which I still believe is a $20 stock at most. I really did a bad job with the FDA approval list. My friend and I came up with a hypothesis that you could make fairly easy money by shorting pharma companies seeking Phase III FDA approval. SGEN and VVUS went up a lot… not a big sample size but the increases are enough to scare me from doing this type of trading.

On the top part of the screen are the longs… much less entertaining to look at. Big losers include YHOO (I liked this stock at $17 unfortunately), XRX, RJET, S, C, GS and MF. (The first four of these ideas I got from Greenlight Capital’s filings.) The latter three all did terribly because almost everything in the financial sector did badly last year. It was just a terrible macro call.

The post bankruptcy list had some massive losers like CODE, GM, VC, and XRM. I used to like looking at post bankruptcy companies just like other event-driven people, but this doesn’t seem smart. Most companies end up in bankruptcy because they are terrible businesses. The key to making money in this arena is to pick something that filed for bankruptcy due to liquidity issues rather than solvency issues… one that is not involved in heavy industry with lots of competition and low margins. But how many GGPs will we see in our lifetimes?

Big winners include AAPL (my favorite secular story of all time), HOS, BUD, and IDT—and AHCI which got bought out.

Oh, and finally on the right side under the momentum category… those were ideas from our resident genius technical analyst. I think CMG is the only winner on that list. Everything else went straight into the shitter. This supports my theory that technical analysis in general has poor predictive value over longer time periods. You’re not supposed to hold on to momentum stocks for long.

Lessons to Take Away

I think it is pretty clear that one cannot make consistent money in stocks reading reports on that site for investors that we all like to visit. The market is more efficient than we think. Macro calls can determine how entire sectors perform and it’s useless to pick the best of the bunch because it will just go down along with everything else. But do any of us make an effort to make macro calls? Most of us don’t.

Frauds are categorically bad investments. That’s for sure.

Fads are dumb to bet against, probably because they can stay popular for a long time before reversing.

Obsolete companies are great to short because the business operating momentum is downhill.

Avoiding pharmaceutical companies (long and short) is a great idea.

This is a good exercise to go through, just to keep my head in check. I want to find true anomalies, and I don’t want to play a game where the outcome is random. Got to find out what is predictive and what is not.

Short sellers hardly ever short great businesses. That is why you can’t make quick money buying Berkshire Hathaway or Coca-Cola, but you can double your money in a month with SHLD (which is a bona fide piece of shit). We have to look for businesses of lower quality, but we can’t be buying absolute garbage, because the short sellers will win on liquidity or bankruptcy risk. We have to stay in the middle of the road.

RIMM is in the middle of the road. Everybody hates this company. It will take short sellers about 4 days to completely cover. I would never buy any RIMM products and I have no clue why anyone does. Their Playbook tablet is just as useful as a paperweight because the apps are terrible (unless you get Android apps). Every one of their phones (over two dozen SKUs) sucks! The software is suited to users from the early 2000s. Does anybody remember the last time RIMM came out with a product that actually took people’s share of mind? No. And yet, RIMM is in the middle of the road because it has no debt. It’s trading at tangible book value. The international business is actually growing because in poorer countries, consumers don’t get iPhones at prices subsidized by the carriers. There’s hope that by the end of the year, Blackberrys will run Android seamlessly. This could save the company.

So I expect shockingly terrible results to come out after the bell tomorrow. Hopefully there’s capitulation in the stock and further capitulation among the put sellers. As the put sellers cover, I will be interested to sell.

Let’s wait and see……………….

John Hempton found no evidence of fraud—JCOM is just using cash from operations to roll up competitors in the electronic fax business and then raising prices. But my issue with this is that the goodwill created during the acquisitions can hardly be called goodwill at all. If you are acquiring businesses that are obsolete, the excess amount you pay over tangible book value is not truly an asset. You can call it an asset just because of accounting standards, but it is very likely that those same standards will require you to write down the “asset” later.

FAS 142 requires companies to test for goodwill impairment once a year. Management is given quite a lot of leeway in determining whether impairment is warranted, so I would think that honesty plays a big part in this. I do not want to imply that JCOM’s management is dishonest, but they have been nothing but sellers of their stock and they clearly do not have much faith in the business. They probably are aware of the obvious: one day goodwill is going to be written down. Do they do it now, or later? What is the right move for them as fiduciaries?

I don’t know. But every day that passes their business gets closer to oblivion. What can’t go on forever eventually has to stop.

Going through the 10-K I found an interesting disclosure:

We believe that one of the attractions to fax versus alternatives, such as email, is that fax signatures are a generally accepted method of executing contracts. There are on-going efforts by governmental and non-governmental entities, many of which possess greater resources than we do, to create a universally accepted method for electronically signing documents. Widespread adoption of so-called “digital signatures” could reduce demand for our fax services and, as a result, could have a material adverse effect on our business, prospects, financial condition, operating results and cash flows.

I recently used a service called RightSignature to legally bind me to purchase a very large purchase of goods. I used my mouse (another thing that will be obsolete) to write my signature:

It looks a little jagged compared to my pen and paper signature:

Who cares? The digital signature looks just fine. I was curious to find out how “legally binding” such signatures are, so I dug up a few things online:

Documents executed on RightSignature have the same legal validity and enforceability of pen-and-paper contracts. RightSignature’s technology is in full compliance with US and EU e-signature legislative acts, which confirm the legality of electronic signatures. The world’s largest companies rely on RightSignature, and users routinely execute multi-million dollar contracts via RightSignature. You can use RightSignature for your business agreements with full confidence.

There is a significant movement toward signing legal documents electronically. You can sign legally binding contracts online and even from your phone. With RightSignature you can upload contracts and have them signed in a faster, cheaper, and more secure way than paper documents.

Wikipedia:

The U.S. Code defines an electronic signature for the purpose of US law as “an electronic sound, symbol, or process, attached to or logically associated with a contract or other record and executed or adopted by a person with the intent to sign the record.” It may be an electronic transmission of the document which contains the signature, as in the case of facsimile transmissions, or it may be encoded message, such as telegraphy using Morse code.

I have never seen a more irrelevant company than JCOM.

The easier thing to do is figure out who loses. What you really should have done in 1905 when you saw what the auto industry was going to do is you should have gone short horses. There were 20 million horses in 1900 and there are about 4 million horses now. So it’s easy to figure out the losers.

-Warren Buffett

Losers in the Post-PC Era

I bought the new iPad this weekend and I can say confidently that it is more disruptive than most people think. In fact I prefer to do most tasks on my iPad instead of my Macbook Air. Browsing the Internet, listening to music, reading books, checking email, looking at pictures and trading stocks is all better on the iPad. There are apps for everything imaginable!

I can say with a high degree of certainty that PC manufacturers as a whole are going to be losers over the next decade. Dell, HP and Lenovo will have consumer businesses that are merely a small fraction of what they are today. It will just take some time for people to realize that the iPad is a superior laptop substitute most of the time.

At the D8 Conference in 2010, Steve Jobs talked about how PCs would fare in the tablet era:

When we were an agrarian nation, all cars were trucks because that’s what you needed on the farm. But as vehicles started to be used in the urban centers and America started to move into those urban and suburban centers, cars got more popular and innovations like automatic transmission and power steering and things that you didn’t care about in a truck as much started to become paramount in cars. And now, I don’t know what the statistics are, but maybe 1 in every 25 vehicles is a truck… where it used to be a lot higher. PCs (laptops and desktops) are gonna be like trucks. They’re still gonna be around. They’re still gonna have a lot of value, but they’re going to be used by 1 out of X people.

And this transition is going to make some people uneasy. People like you and me from the PC world… because the PC has taken us a long way. We like to talk about the post-PC era, but when it really starts to happen, I think it’s uncomfortable. Because it’s change. A lot of vested interests are going to change. I think that we’re embarked on that.

I realize that Dell and HP are cheap and doing big share buy backs. But why would you want to invest in a situation where the end result is merely not as bad as the market expects? Stock prices go up and down with the share of mind and economic rents earned by the underlying businesses. They don’t go up because they are cheap.

Enterprise Users Are No Longer Confused

While waiting in line for the new iPad I met someone who works for a teleconferencing company. It turns out he was there to buy the newly released Apple TV, not the new iPad. His company is going to buy iPads for all the employees. This trend of enterprises buying Apple products is not new. I noticed that Lowe’s employees use iPhones. Restoration Hardware employees use iPads. Airline pilots use iPads to replace their flight manuals. Schools buy iPads for their students. This is really frightening for companies that have traditionally sold product through the enterprise channel. The iPad is particularly frightening because it is so much cheaper than the average laptop and more mobile too.

Not even Steve Jobs could foresee this incredible trend:

We want to make a better product than Google does, and we do. That’s what we’re about. We’re about making better products. What I love about the consumer market that I always hated about the enterprise market is that we come up with a product, we try to tell everybody about it, and every person votes for themselves. They go yes, or no. And if enough of them say yes, we get to come to work tomorrow. It’s really simple. But with the enterprise market, it’s not so simple. The people that use the products don’t decide for themselves. And the people who make those decisions sometimes are confused.

They aren’t confused anymore. They don’t think twice before ditching Blackberry—the shittiest product on the market today.

Mobile User Habits: The Decline of Search

Something really interesting is happening on mobile phones. They’re not mirroring desktops or laptop PCs in that people are not spending their time searching. They’re not doing searching anywhere near as much as they do on PCs. We’ve got all the data. We know this. They’re spending their time in apps. So for whatever reason if people want to find out that restaurant to go to, they’re not going to their search engine and typing in “Japanese in Palo Alto”; they’re going to Yelp. Or whatever other app they want to go to to find out if their airplane is on time. I don’t know why it’s different than on PCs. I think I do but I’m not sure. I think it’s because there never was one place with 200,000 apps where a ton of them were free and the rest of them were really inexpensive, for PCs! I think this app thing’s an entirely new phenomenon in my lifetime, in your lifetime. So I think people are using apps WAY more than they’re using search.

This is a great reason not to buy GOOG.

Dictation—a Very Disruptive Feature

The one thing I still dislike about the iPad is typing on it. Sure it’s bearable, but I prefer to have the touch feedback that my Macbook Air provides. There’s an alternative on the new iPad: to the left of the space bar on the keyboard is a dictation feature! It’s really accurate. Unless you speak using a lot of proper nouns, there really is no reason to type on the iPad anymore.

SoundExchange retains very little of its earnings, distributing virtually all of its income to artists, so it is effectively a mutual holding company owned by participating artists.

Here is a copy of SoundExchange’s financial statements:

Royalty receipts grew 30% from 2009 to 2010 and 20% from 2008 to 2009; expenses have barely increased. Participating artists are bringing home a lot more from SoundExchange every year. These amazing numbers are being posted while overall music industry sales seem to be in a permanent state of decline since the peak in 1997. (See an excellent Business Insider article on this here.)

People don’t BUY music so much anymore. They are listening online. Yet, as we have seen from Pandora’s latest earnings call, increasing listener hours ipso facto is NOT good for their business. Virtually all of the benefit goes to SoundExchange, the rentier. The SEC made note of this in its comments regarding Pandora’s S-1 filing:

“You currently operate under a business plan strongly reliant on lobbied concessions and federal court and federal agency consent decrees and settlements, setting reduced royalty and licensing rates that expire in 2015 and that ordinary rates, not subject to such extraordinary measures, to which you may be subject upon the expiration of these exceptions make your current business plan unsustainable, as discussed in your risk factors.”

If Pandora is doing shitty now, I can’t wait to see how it will do in 2015. All these people who own Pandora stock because they like the service don’t understand the economics of the situation they’re in. Maybe they have never played Monopoly. SoundExchange owns hotels on all the fucking property. Why would you ever want to go around the board in that case?

The best thing Pandora can do is LIQUIDATE the business now before it burns more shareholders’ money. It will never make a profit large enough to justify the current valuation. You have lots of online music radio apps competing for ad dollars (the last thing you want to be doing when you’re dealing with a powerful rentier), and I think Spotify is going to take the lead eventually. Just like virtually all online business, the winner will take everything. We live in an age where Facebook has the power to make or break business models (look at Zynga), and it makes no sense to fight the trend.

I covered my short P position under $11 and will gladly reshort once it gets overbought.

P.S. Tim Westergren still has not replied to my question on Quora about how Pandora plans to deal with Spotify. This is probably because they don’t have a plan.

Digital Garage (4819) owns 11,672,000 shares of Kakaku.com (2371) worth about $350M. It has also invested in Twitter in five small funding rounds. This stake is difficult to value because all we know are the dates that Digital Garage made its investments; we do not know the amounts. According to a shareholder presentation, Digital Garage invested in Twitter on January 7, 2008, June 26, 2008, March 26, 2009, January 26, 2010 and May 13, 2010.

The blog Asiajin reports that Digital Garage’s first investment was “not more than 100,000,000 yen ($915,000).” What a weird disclosure… “not more than 100,000,000 yen” could mean 1 yen, for all we know!

For good measure here is SecondMarket’s list of Twitter’s funding rounds:

So Digital Garage was a very early investor in the most successful social media site since Facebook. As of the latest funding round by Alwaleed bin Talal, Twitter’s implied valuation is $8.4 billion. I think Twitter has a lot of momentum. Not as much as Facebook, but there is clearly a lot of business potential. Here is a transcript of Charlie Rose’s talk with Prince Alwaleed:

Charlie Rose: There is Twitter now. You have a $300 million investment in Twitter. How did that happen?

Alwaleed bin Talal: Kingdom Holding, my company, has invested in Apple, Amazon, eBay, Priceline… so we are not new to that business. Investing in Twitter is just a continuation of us looking at those business opportunities at an early stage. Twitter is done with the venture capital phase and is on its way to maturity level. We believe we came at the right time, and their potential is spectacular and great. They already have 100 million users and more than 250 million tweets every day. And this could go dramatically higher. And the potential for Twitter is dramatic and high.

Charlie Rose: It is said that you made your investment in Twitter after you saw Yuri Milner make his investment. Is that fair?

Alwaleed bin Talal: I don’t even know his name. Who is this guy?

When we invest in a company, we do our homework. We analyze the company and we make projections and we take action.

Charlie Rose: Do you think Twitter will be able to monetize?

Alwaleed bin Talal: Today I met with the CEO and the CFO. I think they are on the right track, and I believe they can monetize.

Charlie Rose: Your wife, the princess, is an avid user of Twitter. And also Rupert Murdoch does. Did you have any influence on Rupert in suggesting that he should look at Twitter and make some tweets?

Alwaleed bin Talal: When I invested in Twitter, just three or four days later, Rupert Murdoch started tweeting. The rumor says I influenced him. I hope I influenced him because that’s good for Twitter to have such a man of such high credibility as Rupert Murdoch to be using it.

Digital Garage has a market cap of $575 million. Subtracting net cash of $12 million and the stakes in Kakaku.com and Twitter (let’s say the stake is worth $70 million) gets us to $142 million. FY2012 net income is projected to be $25 million, so we can own Digital Garage’s business at less than 6x earnings.

What is the business? That’s a good question. They incubate tech startups. They’re a VC shop and have some deals with LinkedIn, Twitter and Technorati. Some information is available in their investor presentations, but I still find their business hard to understand. Here is a slide with more detail:

The main risk is that I have no idea how much Twitter Digital Garage actually owns. Also I have no idea how to measure the quality of Kakaku.com and I don’t want to short it just to hedge out Digital Garage’s exposure to it.

I hate investing in Japanese stocks, and I don’t have a position. Just thought I’d publish something about this puzzle.

“Valuation remains vexing unless one believes, as we do, that the strategic value of becoming a mobile advertising platform justifies a value of $4 billion or more.”
-Jordan Rohan

Why even mention that the valuation is bothersome (read: excessive) if you really believe the stock is worth 50% more than its current price? If this statement isn’t ambiguous, it’s plain bad writing.

I don’t use doublespeak. When I say something is misunderstood and mispriced I really mean it (and I understand full well the risks to my reputation–I am not going to be right all of the time). Pandora is misunderstood and mispriced. Like Mr. Rohan I am a big believer in the potential of online advertising businesses. (I am a Facebook shareholder, for one thing.) However, I think Pandora has the weakest business model of any in the space. The momentum is with Spotify, thanks to Facebook. Spotify is a much better product and a much better investment.

Messaging Tim Westergren

The founder of Pandora, Tim Westergren writes on Quora quite often. 1,366 people follow him, and he follows 150 people. I sent him the following message last week:

Hi Tim,

I have noticed that the time users spend on Pandora.com has steadily declined to about 4 minutes from 11 a few years ago (source: Alexa). It looks like competition is heating up and Spotify is taking market share. Spotify is in many ways a less limiting service and the Facebook partnership gives them an edge. What are you going to do in response to Spotify?

I’ll let you know what he says.

Actually, I am a big fan of lots of Google products. I use Gmail, Chrome, YouTube and Maps–Google is best in class in most things we do online. One rule I have on short selling is: Never short a company whose products you like to use. The reason you use the product is that you prefer it to the alternatives; and if you prefer it to the alternatives, it must be pretty good. You don’t make consistent money by shorting good names, only the bad ones. Ben Graham said as much in his memoirs:

Another operation ended in a goodly loss with comical overtones. I had come to pride myself on being able to detect both greatly overvalued and significantly undervalued common stocks. I would operate on pairs of such securities, buying a cheap stock and selling a dear stock short against it. One of the stocks I considered overpriced was Shattuck Corporation, the owner of Schrafft’s Restaurants. The company was doing well, but the speculators had inflated the price of the shares to what I thought was ridiculous heights. So I bought one of the numerous undervalued issues that I was always digging up and shorted a few hundred Shattuck shares against it.

From the start I had arranged a regular weekly luncheon to discuss my exploits. As it happened, these meetings took place at a Schrafft’s Restaurant which was a favorite with Lou Harris. When we went short on the stock, we all felt it was against our interest to support the enemy with our lunch checks, so we found another place to eat. Time went by and Shattuck stock continued to go up. (It is an inconvenient characteristic of these popular and therefore overvalued issues that they sometimes continue to be popular and grow more overvalued than ever before they drop to a normal and proper price.) When the price had advanced from our 70 to a most bothersome 100, we held a council of war and decided it was unwise to “fight City Hall” any longer. Anyway, we couldn’t expect every operation to turn out well; our overall batting average was high enough; it was good discipline to accept a loss now and then; and so on. So we undid the operation, with a loss of some thousands of dollars. Lou Harris’s comment was “Well, one good thing about taking this loss is that I can go back to eating lunch at Schrafft’s.” We needed the laugh.

After all the news about Google’s invasion of privacy, I stopped using Google Chrome. Not because I do anything online I don’t want people to know about, but because Google’s sketchiness offended me. Well, after a few weeks of using Safari (Apple’s browser), I couldn’t stand it anymore. Now I’m back to using Chrome. The worse thing is I started using Yahoo! as my default search engine. It felt like I was smashing my head against a wood board.

Google is a great company and, despite what some on the Street think, management is capable. I recommend reading the letters of Larry Page and Sergey Brin (http://investor.google.com/corporate/founders-letter.html); they are truly one-of-a-kind in the tech world. Google definitely has made the world a better place, and they’ve figured out a way to make money doing it. The stock isn’t overpriced, given their moats in various businesses. But I wouldn’t want to own it.

Pandora.com’s free service is very limited. It does not allow users to replay or rewind tracks. It does not allow you to listen to a specific artist or song on demand. Pandora’s Human Genome Project is good at suggesting music that users like, but this feature is becoming commoditized. Spotify Radio suggests music. Grooveshark suggests music. Even Sirius Satellite Radio is working on this feature, too, according to my sources.

I think Spotify is in the beginning stages of killing Pandora. Log into Facebook and give it a try and tell me your honest opinion about the user experience. Spotify is A LOT better, in that you can play what you want, when you want. The support from Facebook gives Spotify a huge edge, because it is so easy to access. If you see artists that your friends like, you can just click and Spotify will open.

If Pandora’s decline isn’t showing up in the user metrics, I believe it will soon. And this business model will fail to work if users don’t continue on an upward trajectory. In the first nine months of Pandora’s fiscal 2011, selling advertising amounted to 87% of revenue. Pandora absolutely needs users to come back to the site, or else advertisers will find other places to post their ads.

I am shorting the stock ahead of earnings on 3/6/2012.