An Interview With Hedge Fund Manager Whitney Tilson

Question: What do you get when two of the smartest investing minds in the world answer investors' questions for around six hours?

Answer: A reason for investors from all over the world to travel to Omaha for a weekend in May and pack the CenturyLink Center.

Berkshire Hathaway shareholders may already know that I'm referring to the company's annual meeting, where Warren Buffett and Charlie Munger sit for hours for a Q&A with their investors.

Among the thousands of investors that made the trip to Omaha this year was Whitney Tilson, the managing partner of the New York hedge fund Kase Capital. In the video below, I caught up with Tilson just as the meeting concluded. 

A transcript of the video follows.

Matt Koppenheffer: I'm here with Whitney Tilson, managing partner of New York-based hedge fund, Kase Capital. Whitney, thanks for joining us.

Whitney Tilson: My pleasure.

Koppenheffer: The Berkshire Hathaway annual meeting just concluded. You got an opportunity to ask a question during the meeting, and it was about a book about 3G Capital, called Dream Big. What's the book about, and what was one of your big takeaways from it?

Tilson: It just came out, so I've only read the first chapter or so, but I've actually been following these guys. It's three Brazilian entrepreneurs -- I'll show you a copy of the book and you can see the picture of these guys. I just got a hard copy of it; it literally just came out this week.

It is one of the most extraordinary business stories of all time, rivaling the rise of Berkshire Hathaway, a Sam Walton kind of story, where these guys started in the banking business in Brazil, it must have been back in the late '60s, early '70s. Then they acquired a little brewer -- a beer company -- and started acquiring other companies, culminating with acquiring Anheuser Busch in the depths of the financial crisis in 2008.

They have, from literally a $50 million tiny little third-tier brewer in Brazil, in 20 years they built the world's largest brewer. Then they took over Burger King, and then they've just partnered up with Buffett to buy Heinz in a $23 billion deal, last year.

Their track record is just extraordinary. Buffett thinks they are the best operating managers he has seen in his career, and that's saying something.

I think anyone interested in business and entrepreneurship and success in investing, should study these guys -- and also, if you're a Berkshire shareholder, I think the Heinz deal is the first ... I think Buffett and these three guys are hunting elephants.

It wouldn't surprise me to see them go after Campbell's Soup -- or any kind of consumer company now, I think, is fair game -- with Buffett's deep pockets and these guys' managerial ability. As a Berkshire shareholder, I'm thrilled by this.

Koppenheffer: As always, it was a marathon Q&A session with Warren and Charlie. Were there any surprises for you in what they said? Were there any big takeaways for you in what went on during the meeting this year?

Tilson: This is, I think, my 16th or 17th consecutive meeting, so ...

Koppenheffer: It's hard to surprise you.

Tilson: Hard to get a lot of new stuff. As someone who owns a little bit of Fannie Mae stock, I thought their commentary near the end about the GSEs was interesting. I'd say, really, the very first question right out of the box this morning was about Coke, and Buffett abstaining for the compensation package. He got a lot of criticism, "Why didn't you vote against it?"

I came into the meeting thinking, "You know what I wish? I wish he had voted against it. It would have sent a good, strong signal about the excesses of corporate comp in America and all." But after hearing them explain it, I'm satisfied that they did the right thing -- that he did send a very strong signal.

For Warren Buffett to abstain is a big deal, and they also clarified that the compensation package ... there were reports out there that management was getting like 16% of the company over five years or something, that it would be horribly dilutive. Buffett went through some math that explained it was sort of 2.5% dilution.

Koppenheffer: Not quite the same.

Tilson: Yes. If it were 16%, Buffett would have voted against it. At 2.5%, he abstained -- and Coke, he has personal relationships there. He's obviously by far the most influential shareholder, and so forth, so he quietly and privately communicated with Coke's management, and I think they are going to clean up that comp plan.

I think they did the right thing. It's a very interesting commentary he and Munger had, about the difficulties of trying to bring about change when you're on a board, or a shareholder, and how a board of directors is partly a business entity, but it's also a social club.

As Charlie has said in the past, and said again today, "You belch too many times at the dinner table, you'll be eating dinner in the kitchen." There's a lot of social pressure to get along, and it makes it difficult to really bring about change and rein in comp, and so forth.

It was interesting to hear the most powerful, respected, influential businessmen on Earth say that even their ability to try and change the way things are, is very limited.

Koppenheffer: Kase Capital is an owner of Berkshire Hathaway. That is one of your larger holdings.

Tilson: Yes. It's the only stock I have owned since inception, almost 16 years ago. I've owned it for a long time.

Koppenheffer: That's long-term ownership! I know that's a lot of your investing thesis, just like Buffett's.

Tilson: It has ranged from a 3% position to a 30% position over that time period, depending on how attractive the stock price was, but today it's my second or third largest position, about a 6% position. I'd call it a safe, cheap, 85-cent dollar. It's not screaming cheap, but it's better than holding cash.

Koppenheffer: The question comes up, as it often does, of the size of Berkshire Hathaway today. Do you have concerns about it being able to beat the rest of the market?

Tilson: I would give 80-90% chance that it beats the S&P 500 over the next 5-10 years. But that is not any high bar, given I think after five years of a bull market, I would guess an S&P 500 index fund might to 5% a year, compounded for the next five years or so, would be my guess.

I think Berkshire Hathaway's intrinsic value is growing maybe 10% a year, barring some severe economic downturn or something. I think it is trading at about a 15% discount to its intrinsic value, so there's always a chance that discount closes, which means if the intrinsic value grows 10% a year, that value gap closes a bit, I might make 12-15% a year. You just have to have reasonable expectations.

Berkshire is a "sleep well at night" kind of stock. You've got pretty decent downside protection in that Buffett is willing to buy it back at 1.2x book. Today it's -- off the top of my head -- 1.35x book or something so, much more than 10% downside on the stock from here, and Buffett himself is willing to step in.

There aren't many stocks that have decent upsides, super high quality balance sheet business management, and you have pretty well-capped downside, 10-15% down from here.

Koppenheffer: I spend a lot of time looking at financial companies, and AIG is another holding at Kase Capital. There's been a lot that's happened in the turnaround. Do you have any sense that the turnaround is slowing at this point, or is the momentum still going there, and the business will continue to get better?

Tilson: The stock had a really great run from $30 up to about $50, and it's sort of stagnated the last couple quarters, as the last couple earnings releases haven't been the big beats that they had for the prior year, let's say, that really drove the stock up a lot.

It's still one of my favorite and one of my top three positions. I think it's a fabulous franchise. Peer insurance companies are trading at 1.2, 1.3x book, and AIG is trading at a 30% discount to book, so just on the valuation adjustment to its peer groups, the stock could be up 50-100%.

I also think book value is going to continue to grow, and cost-cutting is starting to kick in. I think they've fixed the underwriting piece of it, and now it's a question of getting costs under control. Everything I'm seeing is they are, but it just takes some time.

AIG, over the next year or two, I expect to do very well. That's why it's one of my biggest positions.

Koppenheffer: Any thoughts on the eventual CEO transition?

Tilson: Not really. I'm forgetting his name off the top of my head, but there seems to be a pretty strong number two there, so that doesn't really affect my investment thesis at this point.

Koppenheffer: In another management story over at Citigroup, you've got Mike Corbat coming in there and everybody's really excited about him. A little bit of a tough year so far this year, most recently, with the CCAR failure. That's another holding at Kase Capital. Any concerns about Citigroup?

Tilson: Citigroup and AIG are actually very similar themes, in my opinion. Both companies basically went bankrupt and got bailed out by the government in the crisis; terribly tainted, terrible headlines.

Both have cleaned up, gotten rid of a lot of the bad businesses, they've run off their bad book of business, yet I think the stocks are still tainted by what happened during the crisis. Both are trading at a discount to book value, and both are fabulous global franchises that are worth at least 1x book, probably 1.2x book.

Citigroup, though, is about half the size position for me as AIG, for two reasons. I have a little more confidence in Benmosche and the turnaround and cost-cutting, and so forth. Probably a little bit better business, and the stock is trading at a better discount to book -- so cheaper stock, better business, better management -- that's why it's a bigger position.

But Citigroup, I would say it's probably got 20% upside, when some of the current short-term noise passes. It was obviously a big disappointment when they didn't get approval to be returning capital, and I think near-term catalysts for the stock were delayed, and a lot of short-term oriented folks just dumped the stock.

But surprisingly, the stock has sort of held up pretty well, actually, just because it's so cheap.

Koppenheffer: And the capital is there, right?

Tilson: Yes. To some extent, forcing a bank that ran out of capital to hold more excess capital ...

Koppenheffer: It's not a terrible idea.

Tilson: As someone who, most importantly, prefers to sleep well at night -- that's a good thing.

Koppenheffer: Kase Capital now also has some short positions. Last year, tough year to be on the short side of the market.

Tilson: I'll say. It was a once every 10 years kind of year, where it was just carnage for short sellers, and a lot of people gave it up entirely. I'm too stubborn to do that, though.

Koppenheffer: This year, we've seen maybe a little bit more turnaround in the opposite direction.

Tilson: Sure. My short book's really been working this year.

Koppenheffer: For investors on the long side of the market, what parts of the market should they be looking out for? What are the danger zones?

Tilson: Just generally, anything with a lot of hype and momentum. It's almost staggering to me that six years after one of the worst downturns and financial crises in history ... I thought it would take another generation -- it would be 20 years -- before unbelievable stupidity and speculation and so forth, returned to the markets, and where we are back at full force.

When I saw "The Wolf of Wall Street" movie, about the bucket shops promoting these fraudulent companies 20 years ago or something -- as I watched that movie I'm like, "Nothing's changed."

I'm short a bunch of companies that I know are being promoted by fraudsters and bucket shops and so forth -- guys just like the Wolf of Wall Street. These tend to be a little bit smaller companies, probably off the radar screen of most investors, but just be careful.

Classic example is the 3D printing sector. Every good fraud or promotion has some legitimacy, some veneer of legitimacy. 3D printing has been around for 20 years. There are companies that have real revenues -- it's not a fraud -- but it just got promoted to the Moon.

A lot of stuff in the biotech space ... the areas where the frauds and promotions tend to occur are medical devices, exciting new technologies, that kind of thing.

Most investors will, by far, be better off sticking to things like Berkshire Hathaway or AIG or Citigroup; solid businesses, trading at low multiples of earnings or book value. You won't have a lot to talk about at cocktail parties, but you're not going to lose your shirt either, and right now we're in an environment where investors should be thinking first and foremost about not losing their shirt.

A lot of these momentum names, they've been cut in half, and they're still wildly overvalued by any ... there are no value guys that are going to step in and support that stock. I think 3D Systems has got another 50% drop in it. The stock went from $10 to $100, and I was short it from $60 on up, and kept pounding the table and warning people.

Really, the peak of it was at the Consumer Electronics Show in Vegas in January. I was out there and they announced that they had just appointed a new creative director, will.i.am, the singer. I said, "This is the sign of a top."

Koppenheffer: That's the jump to start moving, right there.

Tilson: Yes, exactly, and sure enough that day was the stock's peak at $98. Today it's down more than 50%, three-four months later. I just feel bad for the retail investors who got sucked into a giant promotion.

At that point it was trading at something like 20x revenues. I actually posted an article about this -- will.i.am, and this is the sign of a top -- on one of the websites, and someone in the message board said, "Oh, Tilson doesn't know what he's talking about. It's a good company; it's only trading at 20x earnings."

I slapped my head and I said, "That's the problem here. There are people being drawn into this stock who don't understand the difference between 20x earnings and 20x revenues.

Koppenheffer: Kind of a big difference.

Tilson: That's all the difference in the world.

By the way, I haven't covered a share. I shorted more on the way down at $60, stock's in the $40s today. I think intrinsic value is $10. It's not a fraud -- it's not going to $0.

Koppenheffer: There's a business there.

Tilson: Yeah, and it's probably worth 2 to 3x revenues, so my price target is $10. Now, there's enough hype around it that I'll probably cover most of it before it really gets down there, because once it gets down to a low level, you never know. It can get promoted back up, so as a short sell you can't be too greedy.

Koppenheffer: Finishing off on a fun note, a lot of shopping goes on at the Berkshire Hathaway annual meeting, and I noticed that you had a shopping bag with you. What are some of the things that you picked up here?

Tilson: Yes, I always pick up some See's candy, which is my favorite. I picked up a nice new Berkshire Hathaway white polo shirt -- I play tennis -- and then I picked up two books; one, the book I showed you earlier, about the 3G guys who Buffett partnered with to buy Heinz, and another book that I wasn't even aware was out, about the women at Berkshire Hathaway.

My wife was here at the annual meeting last year and asked a question. I have three daughters and she said, "Mr. Buffett, Mr. Munger, I've got three daughters and I want them to be able to do anything in life. When I look at the top of corporate America, I don't see very many women. Is there a glass ceiling? Is this a problem, and what should we do about it?"

Buffett really engaged on this issue. I just noticed in the annual meeting film this morning, where they have pictures of all the Berkshire Hathaway CEOs, now a handful are women. Buffett is trying to be a leader in this area, so I'm really looking forward to reading this book to learn more about the women who have risen to the top of Berkshire Hathaway. Maybe if I like it, I'll have my wife and daughters read it.

Koppenheffer: Whitney Tilson, managing partner of Kase Capital, thanks again for joining us today.

Tilson: My pleasure.