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The Longs Of Whitney Tilson’s Investor Letter: Netflix, Inc. (NFLX) and More

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T2 PARTNERSAfter hedge fund manager Whitney Tilson split from partner Glenn Tongue of T2 Partners in mid-2012 he vowed to sell off some major stakes in the likes of Berkshire Hathaway, Goldman Sachs, J.C. Penney and Netflix, Inc. (NASDAQ:NFLX) in an effort to get the hedge fund to 70% cash. By doing so, Tilson would be able to start fresh. Thus, when Tilson sent out his 2012 investor letter for his new “Kase Capital” I figured it would be worth checking up on the stocks he owns (check out all of Tilson’s picks).

Tilson runs a concentrated portfolio, having only thirteen long positions as of the end of January. He had this to say about his high-concentration…

Since I took over as sole portfolio manager seven months ago, I have purchased/repurchased only eight stocks, seven of which have risen…I am pleased with the fund’s concentrated yet well-diversified long portfolio, which I believe will substantially outperform the market over time.

Let’s get to it. As of the end of January, Tilson’s six through ten largest positions included (see the top five covered in part two):

Netflix, Inc. (NASDAQ:NFLX) is Tilson’s sixth largest pick and was Tilson’s big pick at this year’s Value Investing Congress, and he continues to have a strong affinity for the stock, continuing to note the similarities between Amazon in 2001 and Netflix in 2011, noting they have similar revenues, customer count and market cap.

The video subscription company has been growing subscribers nicely, and the stock is now up over 130% over the last three months. At the end of 2012, Netflix recorded some 27 million subscribers, up from the 21.6 million at the end of 2011. Although its 80x price to earnings multiple means little given the only potential competitor, Amazon, trades at a near 1000x P/E, investors should take solace in analysts’ estimates for Netflix to grow EPS at 18% annually for the next five years.

Some of Tilson’s thought on Netflix includes…

…Netflix can’t be valued in traditional ways such as a multiple of current earnings, cash flows, and/or book value, so I value it based on a probability-weighted scenario analysis. At one extreme, what are the chances that, over the next 5-10 years, Netflix becomes a globally dominant, highly profitable entertainment/media company – in which case, the stock could be a 10-bagger from here? At the other extreme, what are the odds that subscriber growth slows, content costs rise, cash flows turn sharply negative, and Netflix has to either raise capital or sell itself on distressed terms – in which case, the stock would collapse? And what is the likelihood of various in-between scenarios? Last summer, the stock was priced as if the disaster scenario was a real possibility.

Canadian Pacific Railway Limited (USA) (NYSE:CP)
is Tilson’s seventh largest holding and was Tilson’s only new position in the fund since he took over. Worth noting is that billionaire investor and Greenlight Capital founder Bill Ackman had Canadian Pacific as his top 13F stock holding at the end of the third quarter (see all of Ackman’s stocks).

Tilson’s comments on the railroad company included…

It was a chronically under-performing railroad, plagued by an ineffective CEO and a complacent board. Well-known activist fund Pershing Square took a large stake in the company in late 2011 and, after unsuccessfully trying to persuade the board to remove the CEO, waged a successful proxy battle that resulted in a mostly new board and the hiring of Hunter Harrison as CEO. Harrison is a legend in the industry for the remarkable turnarounds he led at Illinois Central and Canadian National and, in owning this stock, I’m making what I think is a high probability bet that he’ll be able to do it again.

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