The bursting of the bankruptcy bubble; GSX Techedu is an obvious bubble and likely near-total fraud; How Berkshire Hathaway May Have Been Snookered in Germany; The five steps to cultivating mentors and developing relationships

By Whitney Tilson

Friday, July 17, 2020
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1) In my June 9 e-mail about the bankruptcy bubble, I wrote:

The bubble over the past week in bankrupt (or near-bankrupt) stocks may be the craziest thing I've seen since the Internet bubble.

Take a look at the gains in these stocks yesterday:

  • Extraction Oil & Gas (XOG): 248%
  • Chesapeake Energy (CHK): 182%
  • Noble (NE): 161%
  • Whiting Petroleum (WLL): 152%
  • Valaris (VAL): 135%
  • Hertz Global (HTZ): 115%
  • J.C. Penney (JCPNQ): 96%
  • RTW Retailwinds (RTW): 74%

Every one of these stocks isn't just likely to decline... they're all ZEROS!

This insanity is being driven by individual investors day trading and speculating like crazy...

It saddens me to see this because while this bubble (so far, anyway) remains microscopic in size, it's still a few billion dollars that these investors are sure to lose – and I suspect these are losses these folks can't afford during these tough times...

In a little more than five weeks since then, this bubble has completely burst... These stocks are down an average of 74%, as you can see in this table:

Company

June 8 Closing Price

Yesterday's Closing Price

Percent Change

Extraction Oil & Gas (XOGAQ)

$1.48

$0.15

-90%

Chesapeake Energy (CHKAQ)

$69.92

$6.60

-91%

Noble (NE)

$0.73

$0.28

-62%

Whiting Petroleum (WLL)

$3.48

$1.08

-69%

Valaris (VAL)

$2.19

$0.63

-71%

Hertz Global (HTZ)

$5.53

$1.44

-74%

J.C. Penney (JCPNQ)

$0.63

$0.27

-57%

RTW Retailwinds (RTWIQ)

$0.41

$0.09

-78%

                  
Don't be tempted to bottom-fish here – as I wrote on June 9, these stocks are all ZEROS!

2) I'm not usually proven so right, so quickly. In fact, I'm frequently early in my calls – as is the case in what I wrote on May 20 about Chinese online-education company GSX Techedu (GSX):

My friend Carson Block of Muddy Waters Research was spot on in his warnings about Luckin Coffee, so investors would be wise to carefully consider his latest report about another Chinese company he believes is a fraud, online education provider GSX Techedu (GSX). Here's his summary:

• We are short GSX because we conclude that it is a near-total fraud.

• We conclude that at least ~70% of its users are fake, and we think it's quite likely that at least ~80% of its users are fake.

• Our conclusions are based on GSX's own user and attendance data files (i.e., this is not from "scraping" data). We downloaded GSX's data from more than 200 paid K-12 classes covering 54,065 unique users.

• In addition, a former GSX manager corroborated our analysis, and explained various details of GSX's extensive bot operation.

• Based on the near total faking of users, we assume that the fraudulent portion of GSX's revenue is at least equal to the percentage of fraudulent users, although it would not surprise us if the ASP on the real portion of GSX's business is fraudulently inflated too.

• We conclude that GSX is a massive loss-making business. Without users, there is no revenue. We also conclude that GSX greatly understates expenses. Regardless of how one cuts it though, GSX is an almost completely empty box.

• Amazingly, Chairman Chen has found a way to make GSX shares even more dangerous for long holders – he has pledged at least $318 million of stock. Long holders of GSX face the risk that the margin lenders will be forced to aggressively sell the stock, crashing the price.

Since then, GSX has risen 145% from $30.58 to $75.01 as of yesterday's close. It now has an $18 billion market cap and trades at 40.3 times trailing revenue. The stock makes Tesla (TSLA) look like a bargain at "only" 11.3 times revenue!

I asked Carson last night for his latest thoughts, and he replied: "It's a near-total fraud, and ramping the stock doesn't make it any more real."

I haven't done the in-depth work Carson has – as I no longer run a hedge fund and therefore don't short stocks – but I have little doubt that he's right about the company and was just early in his call on the stock, which today is in an obvious bubble.

Mark my words: When it bursts, it's going to look like Wirecard (WDI.DE)...

But in the meantime, it certainly underscores how tough short-selling can be!

3) I forgot to include this New York Times article in yesterday's e-mail about Berkshire Hathaway (BRK-B). I can't recall a time when this has ever happened: How Berkshire Hathaway May Have Been Snookered in Germany. Excerpt:

Only a few weeks after Berkshire Hathaway bought what looked like an upstanding example of German engineering prowess, a manager in Warren Buffett's widely admired corporate empire received an unsettling email.

"I have to get rid of something I witnessed in the last few months," the anonymous author wrote in slightly awkward English. "There is a falsification of data going on."

The whistle-blower's tip eventually led to the exposure of an elaborate conspiracy involving fake sales invoices, phantom customers and hacked computer systems, according to testimony in a legal dispute. The case showed that even Mr. Buffett, one of the shrewdest investors in the world, can be hoodwinked.

What looked like a profitable German manufacturer of specialized pipes for the oil and gas industry was, in fact, nearly bankrupt, according to testimony.

As a result, according to the findings of an American arbitration panel, Precision Castparts, a Berkshire Hathaway subsidiary, paid 800 million euros, or $870 million, for a company that was worth only about one-fifth that price.

While embarrassing, it's a rounding error for Berkshire and certainly doesn't change my view about the attractiveness of its stock.

4) In one of the seminars I was teaching a couple of years ago, a student – a young man in his 20s – wrote me the following e-mail:

When I launched my fund, I found myself in a position with no mentors. I didn't have a boss anymore to give me feedback and mentor me so that I perform better (yes, my ex-boss is an investor in the fund, but it is still very different).

I have made lots of connections among peers (people who launched their funds over the past few years) but it is a different type of relationship – mainly discussing ideas.

So I have always been thinking: 'How I can find a mentor in the space? 'Even when I found more experienced fund managers (let's say 10 years ahead of me) and I was able to get their attention because of my research, it was difficult to move that relationship beyond discussing ideas ('Hey, here is a great one! You should look into it!', 'Thank you! Here is one from me!').

I totally get it – people are very, very busy. However, if I can be better at building that relationship, it can move the needle.

In response, I put together a teaching module that, while specific to cultivating mentors, can be applied more broadly to building, maintaining, and deepening all types of relationships.

I started by outlining the five steps to cultivating mentors and developing relationships:

  1. Pick a target
  2. Pre-contact preparation
  3. Initial contact
  4. Follow-ups
  5. Long-term relationship building

In my e-mails in the coming days, I'll share details on each of these...

Best regards,

Whitney

Whitney Tilson
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About Whitney Tilson

Prior to creating Empire Financial Research, Whitney Tilson founded and ran Kase Capital Management, which managed three value-oriented hedge funds and two mutual funds. Starting out of his bedroom with only $1 million, Tilson grew assets under management to more than $200 million.

Tilson graduated magna cum laude from Harvard College with a bachelor's degree in government in 1989. After college, he helped Wendy Kopp launch Teach for America and then spent two years as a consultant at the Boston Consulting Group. He earned his MBA from Harvard Business School in 1994, where he graduated in the top 5% of his class and was named a Baker Scholar.

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