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Avram Fisher, Founder & Portfolio Manager of Long Cast Advisers, is a former equity analyst at CSFB and BMO covering industrials and business services. He has prior experience in private equity; as a corporate governance analyst; as a writer; reporter and private investigator; and as a lifeguard and busboy (I still clear plates when my kids don't). This blog is an open book of ideas about patient investing and about starting up a small-cap focused RIA. It is part decision-diary, part investment observations and part general musings. Nothing on this blog is a solicitation for business nor a recommendation to buy or sell securities. It is simply a way to organize and share thoughts with an expanding audience of independent, patient and talented small cap investors. www.longcastadvisers.com

Thursday, April 7, 2016

Hinkie's "Letter to Shareholders" and the Hubris of Intellect ($FHCO, $BRK)

Sam Hinkie, the 76er's GM resigned Wednesday with a 13-page resignation letter that reflects the convergence of my two great passions: Investing and Philly sports. The entire piece reads like a letter to shareholders, opening with a reference to Atul Gawande and an admission by the author that "Reading investor letters has long been one of my [guilty pleasures]."

Still on the first page, he quotes Warren Buffett. By the second page he's quoting Seth Klarman as well as Charlie Munger's two step process for decision making:

On page four, another Buffett quote / reference AND Howard Marks. On page six he quotes TED-talker Tim Urban ("one of tomorrow's polymaths").

By page 7 he's writing about disruption and quotes Max Planck: “A new scientific truth does not triumph by convincing its opponents and making them see the light, but rather because its opponents eventually die.” He even throws in the word "zugzwang" somewhere towards the end.

Let me remind you, this is the resignation letter of a basketball GM. Red Auerbach is barely mentioned.

There's a cognitive dissonance in the letter that might be lost on someone who doesn't follow sports but the record shows that over the last three seasons Hinkie's 76ers have won just 47 games out of a total of 242 played. That's a 0.24 winning percentage.

Even while Sam Hinkie quotes smart people, indicates a practice of and reverence for incredible investors, he built a team that has one of the worst three year records in the history of professional sports. And he's leaving before he can really test his capabilities.

The whole thing is funny to me almost in the way it would be funny for a passenger to learn that his pilot studied from the greats, but never learned how to land.

To his credit, and as Hinkie's letter points out, the team's plan all along was losing in order to acquire assets. When Hinkie was named GM, he inherited a bad team with few good options and the goal was to acquire future assets for long term success by losing a lot in the short term, getting high draft picks and drafting good young players with "upside."

So looking at the record alone isn't fair to Hinkie. But his resignation tells another story.

Although changes in the executive suite resulted in his having to share power with more traditional basketball minds (Bryan Colangelo) his leaving now, near the moment when he'd harvest the results of his three years of tanking, sounds like ego and emotion acting over wisdom. That is distinctly un-Buffett, un-Klarman and un-Marks.

Everyone wants to compare themselves to the greats but when we look in the mirror, unless we have the record to show a comparison, we can't.

The best we can do without such a record is humbly ask ourselves what we are doing to pursue and reveal truths, first about ourselves and then about the world around us. "To seek the truth and knowing it, give the light" is the one thread that binds all great minds, people and art.

I'm not sure what truth if any Hinkie has revealed in his tenure or his departure except that it's unlikely anyone will try this extreme case of tanking again. If he had any success at all, it's in setting the team up for the future. As he states in the letter, and I include his underlines for emphasis:

"In the upcoming May draft lottery, we have what will likely be the best ever odds to get the #1 overall pick (nearly 30%), a roughly 50/50 chance at a top-2 pick (the highest ever), and a roughly 50/50 chance at two top-5 picks, which would be the best lottery night haul ever. That same bounce of a ping pong ball (almost a flip of a coin) will determine if we have three first round picks this year (unusual) or four (unprecedented). That's this year. Or this quarter, if you will.

If you were to estimate the value of those firsts and the ones to follow, from this point forward we have essentially two NBA teams’ worth of first round pick value plus the third most second round picks in the league."

Talent evaluation and stock picking are bound by the same science of projecting and valuing some unknown future.

Today's investors are told to punt on stock picking and just buy a diversified portfolio. Hinkie does the same by accumulating a volume of assets instead of focusing his efforts on finding the right ones. Again, this is the un-Buffett approach.

Is Hinkie a good talent evaluator? It takes at least three years to known and none of the first round players they've drafted or acquired over the least three years have played for that long or are still on the team. (An example of Hinkie's work is with Michael Carter Williams, drafted in 2013 #11, named Rookie of the Year, and then traded for future draft picks that they will harvest this year).

Maybe Hinkie knew the edge of his competence so he compensated for it by accumulating a volume of picks so he could diversify. This would explain his penchant for accumulating 2nd round picks. Or maybe the Sixers execs compensated by bringing in someone they felt was a better talent evaluator. either way, Hinkie won't be around to conclude what he started and it may be awhile before he finds another job in the NBA.

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It's also funny to me in context of yesterday's merger announcement by $FHCO.

It is one of the strangest, surprising-est and most bizarre capital allocation decisions I've ever seen in that it combines a one-product company owned primarily by value investors who are attracted to a balance sheet and cash flow, with Aspen Park Pharmaceuticals, a bio-tech company that owns patents / has rights to some prostate-cancer drugs, new formulations of existing drugs and also has a consumer product "Preboost" that uses a topical anesthetic wipe to alleviate premature ejaculation.

I reckon the pairing makes sense in that it combines an unusual and irrelevant male consumer product with an unusual and irrelevant female consumer product.

I can further imagine the CEO of FHCO being sold on the merger idea simply with the promise that as a combined company, the marketing genius behind Preboost would bring the FC2 to consumers.

I've written about $FHCO in the past and have long thought that its CEO and Chairman OB Parrish has too much of a beloved view of his product, and in an unconsciously patronizing way. As I've learned talking to social workers and other professionals in the sex work community, the FC2 is a joke with likely no consumer market outside of novelties, but even the novelty market at a certain price has an investment thesis (eg $BRK owns Oriental Trading).

Why a product that received FDA approval in 2009 isn't already on the shelves has been a mystery to me for years, particularly if the company fumbles its market lead if FDA re-classifies the device. Parrish told me once - with no irony - of seeing the FC2 on the shelf of a corner store in an upmarket section of San Francisco selling for $15 / pack  (nearly 5x retail price) and the grocer telling him that its used by gay men off label for anal sex.

Yet, he didn't seem to appreciate what that meant about supply / demand and what could happen to sales if only they would get their product on the shelves in a variety of cities with large gay populations.

Needless to say, I should have stopped trusting the CEO, himself sitting on losses, to make wise and sound capital allocation decisions with the belief that I could go along for the ride, which has now taken a very strange and unusual turn.

I read the current move as a hail mary by someone near retirement age and sees this as his best way to turn a weak hand into a potential high return.

When I asked him why he didn't just sell half the company and buy powerball tickets and he laughed. I presume he thinks a bio-tech has greater opportunity for success than a lottery ticket. Time will tell. If there's a lesson in both these stories it's to invest with managers who can fly the plane and also land it.

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ALL RIGHTS RESERVED THIS IS NOT A SOLICITATION FOR BUSINESS OR A RECOMMENDATION TO BUY OR SELL SECURITIES DO YOUR OWN HOMEWORK

2 comments:

  1. Great post. What's the best way to get in contact with you, we have a holding in common I'd love to compare notes on?

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    1. Hi ... thanks for the feedback ... I think my email is on my profile page (?) but you can reach me on >> aviATlongcastadvisersDOTcom

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