Monday, 20 December 2010

Two Sides of a Short Position - A High Quality Argument on Netflix

During my time as an analyst of hedge funds in 2000-2002, and later as a consultant working on portfolio management and risk management issues with hedge fund portfolio managers, I have been granted the privilege to hear the fundamental cases for positions taken by very good managers. Hearing about a single position in detail gives a potential investor or investment advisor some insight into how managers think about their positions. When consulting I would always ask how typical the sort of position is, as there is no structural insight given in hearing about something that is outside the usual style for the manager.

I look for several key points during discussion – how did the idea arise; what made the manager devote the scarce resource of research time to the company/industry; did the manager procure or carry out primary research on the company; at what level of the company has the hedge fund manager met management and how often; what sort of catalysts does the PM like to see, and has the hedge fund manager identified a catalyst for a change in fundamentals or for a change in (stock) market perceptions? All of these points will enable an outsider to gauge whether there is an edge in research. Consideration of the edge (if there is one), along with the breadth and depth of human resources in analysis, and a view on the creativity/fertility of the manager's mind, will feed into an assessment of the quality of the manager's alpha source and the potential for consistency in the alpha stream.

So it is I read with interest the published debate about Netflix between Whitney Tilson, the value-oriented founder and Managing Partner of T2 Partners LLC (, and Reed Hastings, CEO of Netflix Inc. You can find Tilson's full rationale for his short position in Netflix at, and the response by the Netflix CEO at Most unusually for such a dialogue, it is a very high quality argument.

In this case the Netflix short is smaller than any of the top ten longs in the T2 portfolio. The fund manager does not have to be right on any one position, but how he (or she) deals with being right/or wrong in money management terms is important.


  1. Thank you for sharing. Truly intriguing to read about the two sides of this debate. I personally think Mr. Hastings was not convincing or specific enough in his answer to change a short sellers mind.

  2. Recent stock price action in Netflix shows that the argument has been won by Whitney Tilson. Netflix share out-performed the market for the first half of 2011, but have since gapped down to lose 60% of their value from the high of $300 a share.

    Fundamental shorts do not necessarily oblige to the downside in short order (riff intended). The business model has to be shown to be flawed by results. This one has been in the last month.

    T2 Partners 1, NFLX 0.