Bill Fleckenstein

» Kirk - Investor Profile: Fleckenstein bets against tech

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Tuesday August 20, 1:56 pm Eastern Time
Reuters Market News
Investor Profile: Fleckenstein bets against tech
By Deepa Babington
http://biz.yahoo.com/rf/020820/column_pr...

NEW YORK, Aug 20 (Reuters) - A printout on the wall of Bill Fleckenstein's small office shows soaring stock quotes from the time that Nasdaq reached a seemingly unstoppable 5000 points on March 7, 2000.

It serves as a reminder of the terrible days when the veteran short seller's gamble against technology companies coincided with the dot-com mania that sent tech stocks on a wild ride.

The long-haired contrarian's fortunes have since turned the corner. He is still shorting tech stocks like Intel Corp. (NasdaqNM:INTC - News) and Micron (NYSE:MU - News), but now, his $85 million short-only fund is posting handsome returns in the current bear market.

Fleckenstein is not apologetic about the days he lost money betting against popular wisdom.

"The best lessons all come from when you lose money," he said in a recent interview. "The whole trick in making money is to keep your errors to a minimum. I made every kind of error there is. Nobody goes out and bats 1000."

Fleckenstein, 49, is one of many short sellers who benefitted from the burst of the Internet bubble and more recently, Wall Street's doldrums after a spate of accounting scandals.

Short sellers, who bet that a company's share price will fall, borrow a firm's shares and sell it immediately, in the hopes of buying it back at a lower price and pocket the difference as profit.

It's a risky world. While those who buy stocks stand to lose only as much as they've invested in a worst case scenario, there's no limit to the losses short sellers can incur because shares can keep rising.

The money manager remains tightlipped about the exact performance of Fleckenstein Capital, the hedge fund he manages, saying only that it has posted gains of well over 20 percent this year. Among the hedge funds tracked by the service MAR, short sellers were the best performers this year, with a median return of more than 11 percent through the end of May, said Michael Ocrant, editor at MAR.

SCOURING TECH TARGETS

Arriving in his Seattle office by 6 o'clock every morning, Fleckenstein scours the technology world for targets to short.

"When most people look at the tech world, they see glamor, fizz and fast growth. When I look at technology, all I see is a lousy business," he said. "Because as sexy as all these products are in technology, there's really no barrier to entry -- other companies can copy the design and be in the same business."

While many short sellers scrutinize balance sheets for accounting irregularities, Fleckenstein chooses his targets by keeping his ear to the ground for any hint of bad news from tech companies' customers.

"They have public customers and suppliers so you can triangulate in on the timing of when things might go wrong," he said. "And for the last few years, it's very important to get timing right because in the meantime you can get your lungs ripped out being short something waiting for it happen."

Once he is interested in shorting a company, Fleckenstein zeroes in on its customers. He then gets on their conference calls and listens to what their executives have to say for clues on the problems the company may be facing, he said.

The companies that top his short list are well known in the technology world. On a recent Wednesday morning, Fleckenstein rattled off names such as Intel, Micron, Applied Materials Inc. (NasdaqNM:AMAT - News), Dell (NasdaqNM:DELL - News), and CDW Computer (NasdaqNM:CDWC - News) as his top short picks.

The strategy cost him during the tech boom, but paid off dividends when the bubble burst two years ago. He says he started shorting Gateway Inc (NYSE:GTW - News), for example, after becoming curious about the company's claims that it was growing because of its retail outlets. He says he sold Gateway shares at $58 and bought it back when it tumbled down to $5.

BULLISH TO BIG BEAR

A math major in college, Fleckenstein first became fascinated with the stock market during the late 1970s when inflation was raging and interest rates were high.

In 1979, when he was still in his 20s, Fleckenstein stepped into the investment world as a stockbroker after a stint dabbling in the computer business. He recalls that one of the first stocks he bought was the aerospace company Boeing Co. (NYSE:BA - News) It was also one of his first lessons in losing money.

Three years later, eager to manage money, he started his own firm, Fleckstein Capital. At that time, the bear says, he was "wildly bullish."

In fact, Fleckenstein, married with two teen-aged daughters, didn't short stocks until several years later, and didn't become a full-time bear until more than a decade after that.

"I left the long side of investment in late 1995 because I thought what was happening would end badly," he said.

At first it was smooth sailing. But the pendulum began to swing against him towards the end of 1998, as the markets' fascination for Internet and hi-technology stocks started moving into high gear.

With his news terminal flickering with stock quotes that were racking up astounding gains, Fleckenstein's losses mounted. His heart in his mouth, he one day watched shares of Micron -- in which he had a large short position -- shoot up 20 percent. He even considered quitting.

"I've enjoyed plenty of pain," he said. "There was an 18-month period where getting burned would be putting it mildly."

But by early 2000, when tech stocks lay in tatters, Fleckenstein was beginning to look like one of the smart guys.

His long-time friend James Grant, the editor of Grant's Interest Rate Observer and another well-known bear, calls Fleckenstein among the most "tenacious people on Wall Street" for sticking to his guns and crying foul on technology stocks when everyone else was profiting wildly.

"I've observed him over the years, not giving an inch to the mania," Grant said. "Others have made peace with it in some way -- over the years they developed hedge strategies. But he never gave in. He remained defiant."

Others consider short sellers -- among the most despised groups on Wall Street because they are viewed as playing on the fears of investors -- as simply those who come into the limelight each time the markets swoon.

"This is their time; they are the oracles now," said Robert Willens, an accounting analyst at Lehman Brothers, who has little respect for short sellers. "They go through their phases and then their time will end, as it always does."

-- posted by Kirk

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» Kirk - Contrarian Chronicles

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Contrarian Chronicles

The long and short of short-selling

This isn't a sport for amateurs. The downside is limitless, the subtleties complex. If you have the time to do the homework, here are some of the lessons I've learned the hard way.

By Bill Fleckenstein
Will everybody just settle down and squeeze together along the dissection table. No, you have not accidentally clicked onto some interactive biology lab. It's the latest chapter in the formaldehyde-free Contrarian Chronicles, where this week I'll offer a cross-sectional look not at splayed frogs but short-selling. Because of its complicated nature and inherent risk, this will be a demo class only. Still, fasten your safety goggles, and let's lace into that bird’s-eye view.

I'd like to devote these pages to a discussion of short-selling, in the hope of answering the many questions I have received on the subject. Let me be clear from the outset: My goal is not to advocate short-selling but to differentiate it from investing on the long side and to highlight what I think are some of its complexities and complications. The reason I offer this caution is not any belief that people at home are not smart enough (I'm sure they are), but rather because of the time-intensive "babysitting" involved in monitoring positions. This is just how I do it, after many years of working the problem, but other successful short-sellers do it differently.

Portfolio plumping through value ingesting
First of all, let me preface my thoughts with some comments on the value approach to investing. When investing on the long side (as I have done in the past and will do again in the future), I am a value investor. Without going into everything that this means, the one thing it allows for is averaging down as your initial investment "goes against you." Many, many times in my career, I have successfully averaged down in positions. If you have the confidence in your research that you are not averaging down into a WorldCom (WCOEQ, news, msgs) or an Enron (ENRNQ, news, msgs) or some other debacle, averaging down allows you to enhance your rate of return.

For instance, suppose a stock that you're interested in is selling for $50, and for whatever reason, you think it could go up to $100. If, the stock drops to $40 and you decide to buy it because you are confident that the value is there -- and that the perception of the problems is overblown -- and it then goes to $100, obviously, you're going to make 150% on your money.

Whereas, in the same situation, if you don't buy it when things are looking rather bleak, and you wait until the situation improves somewhat, perhaps you pay $60 for it, you are paying up only 20%. But if the stock goes to $100, your rate of return is going to be 66%. So there is just one example of how, if you're confident that your analysis is correct, averaging down into bad news really helps your rate of return.

Apples-and-orange futures
Now, let's segue to the short side, where I believe that averaging up blindly can lead to disaster. Before going any further, I'd like to introduce one other element here: In the art of speculating in commodities, price action means almost everything. Commodity traders call it "price discovery." Successful commodity speculators don't often average up or down as the price goes against them (preferring to "average in," as the price goes in their favor). They might add to their positions a little bit as the price goes against them; however, when faced with a big move against them, they generally close a position and re-enter at a later period. Fundamentals do matter in commodities speculation, but price action tends to be a far bigger determinant, at least for people who are successful at it. The aspect of price action is much more important in commodities speculation than it is for a value investor on the long side.

As you can see from my previous example, I don't put much faith in price action when I am an investor on the long side. But on the short side, it is often necessary to cut and run if, say, you are short a stock at $20 and soon after it goes to $25, for reasons that you don't understand or which really shouldn't be happening. Often, it's wise to reduce your position, or eliminate it entirely, and then revisit the subject at a future date, whether that might be later that day, a week later, two weeks later or a month later.

Believe me, that was a hard and expensive lesson for me to learn, and it's hard for anyone who comes from the value school to learn, in my opinion. Also, I would just point out that this is not necessarily the way everyone does it, just the approach that I have found to be successful.

In any event, the reason you have to be much more sensitive about price on the short side is that your losses are of course potentially open-ended. When you have a problem in your short portfolio, it gets bigger, whereas when you're investing on the long side, if you have a problem, it gets smaller. You buy a stock at $10 and it goes to $5, your investment is now reduced. You short a stock at $20 and it goes to $30, the size of your investment has now gotten bigger. So, there are complicating factors that I believe necessitate paying attention to price action.

Short-selling satisfaction through delayed herd-reaction
Obviously, when you are short, you're generally taking on lots of other people, meaning it's vital to get your research correct. Further, in view of what I've described, timing is more critical, though just as elusive, on the short side than on the long side. During the last five to seven years, the presence of some sort of catalyst has been crucial for getting people to reappraise their long positions. Often, a company had to come out and tell you, hey, we're going to miss the numbers, or some variation on that theme, when it's been completely knowable in advance that this outcome would be in the offing.

But investors don't seem to take that into consideration until the company actually says so itself; i.e., stocks generally don't tend to move down in advance of bad news. Whereas on the long side, stocks will sneak and creep and work their way higher in the absence of a catalyst, i.e., move up in advance of good news. This may change somewhere down the road. It wasn't always that way in the past. But for the last several years, and until it does change, the onset of a catalyst has often been important for convincing people to re-evaluate their positions and sell a stock.

Consequently, that is the reason I focus on technology. Most technology companies have public suppliers and public customers, and that allows you to have a chance to triangulate in on how a particular company is doing. Also, most of the time, tech companies don't have the flexibility, in terms of accounting, to attempt to change things materially. When they do, by stuffing the channel, it shows up in their accounts receivable. Or, if they try to play the game with margins, it turns up in inventories. So a lot of the classic things they do surface rather easily. This doesn't mean that people will immediately care, but at least you can see signs of trouble building. (Financial stocks, by comparison, can fall back on more flexible accounting rules, with respect to how they view their assets, and thus postpone the day of reckoning ad infinitum, it seems to me.)

Of triangulation and nascent elation
Of course, the other important reason tech stocks are interesting is the inherent factor of obsolescence, which makes technology such a crummy business. Even today, the prices for those businesses are still absurd, in many cases. So, it's an interesting pond to fish in, for all three of the reasons I've stated: the difficulty of the business, the richness of valuations and the ability to triangulate on the timing of a negative catalyst.

While you are waiting for your catalyst to develop, whatever that may be, it's important to try to keep the fantasy, or the imagination component, of the bull camp at bay. This is why the preannouncement season (a month or so before the quarter ends) is a riper time to establish positions than just after the end of earnings season. It seems that no matter how bad the news is, as soon as the bad news stops, fantasies resurface, and people reaffirm their desire to bid these companies up. So, here is one additional factor to pay attention to: where you are in the corporate news cycle, whether you're in the "no news" season or the preannouncement period. That said, just being in either one of those two seasons doesn't mean that you can't have news, or have the absence of news. This also has to be taken into consideration.

Ingredients in the big macro
Lastly, one has to assess the overall macro environment, vis-a-vis whether people have become overly bearish or overly ebullient. For example, last fall, a couple of weeks after Sept. 11, I covered almost all my shorts, because I felt that from a macro perspective, people were going to believe that the terrorist attack was the cause of all our negative developments in the stock market and the economy (even though I knew it wasn't), and that as we went to war in Afghanistan and won easily, people would become optimistic. I felt it would be difficult for stocks to go down in the short run, and I said so at the time. That kind of a macro call was important last year. Yet, as you can see, it had nothing to do with anything I've described thus far.

So, I think one can see the many considerations that go into running a short portfolio which are not necessarily present on the long side. It is for these reasons that I advocate that people at home who don't have full time to devote to it, and who are not experienced, not try to do this, because it is so time-consuming and complicated. Often, I use puts in lieu of short-selling, but because of the premiums involved, and the necessity of getting the always-elusive timing even more precise, puts are no panacea, either. I'd like to repeat that the tactics I have described are not the only ways of doing it. This is just what I find most successful.

William Fleckenstein is the president of Fleckenstein Capital, which manages a hedge fund based in Seattle. He also writes a daily Market Rap column for TheStreet.com's RealMoney. At time of publication, William Fleckenstein owned none of the equities mentioned in this column.

-- posted by Kirk

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» Kirk - Says Short AMAT, DELL, IBM, KLAC & LLTC

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Says Short AMAT, DELL, IBM, KLAC & LLTC

Stocks to Avoid http://www.siliconinvestor.com/stocktalk...

Edited by Len Costa December 2002, Worth Magazine

Starry-eyed investors have pushed these tech favorites to unsustainable valuations, says short-seller Bill Fleckenstein.

In fall 1999, hedge fund manager Bill Fleckenstein warned that shares were dangerously overpriced, but nobody wanted to listen. Now may be a good time to pay him heed. Despite the correction, the founder of Fleckenstein Capital, a $100 million short fund in Seattle, says that many technology stocks still have further to fall. "They're nowhere close to their valuations in past down cycles," he says. A former software programmer, Fleckenstein develops short ideas, including the six below, by uncovering bad news from tech companies' customers and suppliers. Investors are confusing big price declines with value, he says. "How far a stock is down means nothing."

APPLIED MATERIALS
Headquarters Santa Clara, CA
NASDAQ AMAT
Fair Value $6
Selling At $14

Shares of the world's largest semiconductor-equipment maker are priced for a return to prosperity. Don't count on it in 2003. Despite a severe cyclical downturn, Applied sells for nearly five times trailing revenue; it has troughed in the past at 1.5 times revenue. Excess chip capacity means customers are in no position to upgrade equipment.

DELL COMPUTER
Headquarters Austin, TX
NASDAQ DELL
Fair Value $12
Selling At $29

Dell's lofty multiple of 36 times its fiscal 2003 EPS estimate is the result of misguided hopes that a major PC replacement cycle is just around the corner. Customers have no reason to upgrade, though. Average prices for PCs are falling, pressuring margins. A move into price-sensitive markets for network switches and storage products won't help.

IBM
Headquarters Armonk, NY
NYSE IBM
Fair Value $42
Selling At $74

Big Blue is an accounting house of cards. During the mania, IBM used pension earnings to manage its bottom line; now it will invest up to $1.5 billion by 2005 to plug a shortfall. Its services business looks vulnerable, but investors can't be sure: Like troubled rival EDS, IBM uses murky percentage-of-completion accounting to book the revenue.

INTEL
Headquarters Santa Clara, CA
NASDAQ INTC
Fair Value $8
Selling At $16

With sales and earnings flatlining, Intel is cutting jobs and slashing capital spending. The company faces a structural dilemma: Its business is built on getting customers to buy high-end processors, but low-end ones work fine for most tasks. Given its build-up of capacity, Intel may have to take big depreciation charges if sales don't pick up.

KLA TENCOR
Headquarters San Jose, CA
NASDAQ KLAC
Fair Value $12
Selling At $34

Hope springs eternal. When this chip-equipment maker reported a dismal September quarter, its shares rallied nearly a buck. KLA sports a bull market valuation of more than four times revenue. Without growth in KLA's end markets, the party can't last.

LINEAR TECHNOLOGY
Headquarters Milpitas, CA
NASDAQ LLTC
Fair Value $14
Selling At $28.50

This analog chipmaker enjoys fat profit margins because its technology is customized for electronics goods. But its stock is no safe haven. Linear expects its December quarter to be flat or slightly up. Trading at 17 times sales, Linear has no room for error.

-- posted by Kirk

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