Scott Fearon

The 14th episode of Read the Bull is an unfiltered discussion with Scott Fearon, author of "Dead Companies Walking: How a Hedge Fund Manager Finds Opportunity in Unexpected Places," published by Palgrave Macmillan in 2015.  If you want to know how a veteran long/short hedge fund manager approaches investing, this is the interview for you.

Scott started Crown Advisors Management, a long/short equity hedge fund, in 1990.  He manages around $180 million and invests in small and mid-size public companies that have around a $200 - $300 million market cap. He invests on the long side in companies he finds that are undervalued, and also shorts companies that he believes are headed for zero.

Before Scott started his firm, he worked at Texas Commerce Bank in the 1980s. It's there he learned the value of face-to-face meetings, and he tells Stefan that he's visited and met with the management of every company he invests in on the long side. At the time of the book's publication, he had visited 1,400 companies. Now, almost 10 years later, that number is well north of 2,000 companies.

When he started to write "Dead Companies Walking," Scott looked back at the 200 companies he'd shorted and gone bankrupt and found they all made the same strategic mistakes. Scott distilled those mistakes into six themes for why a company fails - Historical Myopia, Getting too Attached to Formulas, Disregarding or Overlooking Your Customers, Madness and Manias, Failing to Recognize Tectonic Shifts, and Not Accepting Blame or Incorrectly Assigning Blame to External Forces.

Some of the stories are well known - Blockbuster's failure to recognize the shift to digital streaming or JC Penney's CEO Ron Johnson ignoring its customers by shifting to a no-sale strategy and bringing in more fashionable merchandise. Others are not as well known - Quokka Sports - a company that wanted to bring immersive viewing to Yacht Racing or First Team Sports, a company that went all in on inline skating. Scott also discusses some of his recent company visits and reveals a couple that he believes will ultimately go to zero. He also talks about why short selling is good for markets and notes that highlights three categories - fads, frauds and failures. 

Scott's not immune to failure himself, and he walks Stefan through mistakes his made, including what led to the demise of his first restaurant.

Scott is not your typical hedge fund manager, or at least not the one you typically read about in the Wall Street Journal or see on CNBC. He stopped taking outside capital years ago and focuses solely on finding companies to invest in or to bet against. That means he doesn't have to market his fund or raise new capital to grow assets like many hedge funds out there.  It also means he can also speak truth to power and pull the curtain back on some of the things that are wrong with the industry. For example, he criticizes hedge fund managers who chase assets, as well as the allocators who cheer them on.

Scott's book is timeless and there are lessons here for everyone - whether you own a business, work for one or are investing in them. 

Go to ReadTheBull.com for more information.

Transcript

Hello, and welcome to Read the Bull, the only podcast dedicated to finance and investing books. I'm your host, Stefan Prelog, and today I am thrilled to welcome Scott Fearon.
Scott is a founder and president of the Hedge Fund Crown Capital Management, and he's also the author of Dead Companies Walking, How a hedge fund manager finds value in unexpected places.
The book chronicles his 33 years of experience in the investing management industry. Scott holds a BA from Stanford University and an MBA from the Kellogg School of Management at Northwestern University.
Welcome, Scott. Thank you, Stefan. So full disclosure-- well, not full disclosure. Scott and I have known each other a long time. I actually did PR in his book, the book was published back in 2015.
So Scott, we're coming up on the 10 year anniversary if you could believe that. Yes. So it was published in 2015 by Paul Grave McMillan, had a great time doing the PR in the book.
You know, on this podcast, we discuss books that are new. We also just discuss books that have stood the test of time. And I really, You know, it doesn't matter that I worked on the book.
Even if I didn't, this is one of the books that has stood the test of time. You know, I like to dive into finance investing books that either tell a great story and you learn something about finance and have some useful insights for people about how the industry works.
And Scott, I think your book is that rare book that has a great story and is also useful for investors and CEOs. And really, since I've launched this podcast, I've been wanting to talk to you, so thank you for doing this.
Now, you're based in Marine County, but where are you today? I'm in Portland, Oregon. I just, yesterday, I just visited, I'm still doing this, visiting 80 to 100 companies a year.
I spent earlier this week visiting seven companies in wonderful Seattle, so Alaska, Nordstrom. I was at Starbucks office just yesterday afternoon and a couple of smaller companies you probably never heard of,
a remitly radiant logistics micro vision. I'm still running screens and visiting a lot of companies. Okay, that's great because Starbucks is,
again, you talk about it because it was one of the companies way back that you had a chance to invest in on the long side and you should say you run run a long short hedge fund,
this book looks a lot about companies, dead companies walking that failed, but that's not how you make money, you're a long investor too, and you go out and visit companies, so when you wrote this book at the time you had visited 1 ,400 companies,
is that right? Yep, we're north, well north of 2 ,000 now. I guess for our viewers and listeners, a long short hedge Fund Manager. Well, Scott, I'll let you explain what you do.
We manage $180 million and we own 40 to 50 stocks and we're short 70 to 100 stocks at all times. And I like to get my stocks are mid -caps and smaller and the simple belief that if there are pricing inefficiencies to be exploited by thorough research on on the ground research,
they're gonna be middle -sized, never S &P 500 names. So yesterday was a weird day going to Starbucks 'cause that's overanalyzed with 40 analysts on Wall Street. But that's what we do.
So we grind, I do not take new investors, I stopped taking new investors years ago, 180 million in assets, why keep it small so that I can invest in smaller companies?
There are especially as it relates to shorting, you know, companies that have a market cap of 200, 300 million. I couldn't run a half a billion or a billion. Immediate family is about 30 % of the assets now,
so you can map that out and conclude you don't need more money under management. It's still fun. Yeah. Well, I like that you asked a question that I didn't ask, but I was going to, why keep it small? I put it in the book.
I have to say this, you know, there's a famous, famous fund manager named Cliff Arnes, who I saw speak, but I've never actually shaken his hand. And he said, you know, hedge fund managers, most hedge fund managers charge too much,
they hedge too little. I would add, and they manage too much money. I mean, you can make a lot of money with a 20 % of the gain each year,
plus 1 % of the management, which is a management fee. You don't have to run a billion or two billion and in fact, as you get bigger, you're precluded from investing in smaller companies where there's arguably more pricing and efficiency.
So I would add to Cliff Arnest's hedge fund managers charge too much, they do, they hedge too little partly because many are too large in assets and thirdly,
they do manage too much And so by for every good reason the higher I've always felt the higher quality people keep their assets at a quote Manageable size.
I have very low respect for these guys that run a billion or two billion or three billion And I probably have even less respect for the pension and endowment hound hot shows That cheer them on as they grow and grow and grow,
you know, these are duplicitous They're not really looking out for their funds return as much as they're trying to justify their existence. Simply because they're limiting their potential to maximize their return by growing their assets.
Right. Well, it's a great point. And you do discuss this in the book that, you know, when you get to like Starbucks or all these big companies, there's so much research,
there's so much out, there's so much information, like the Prices are pretty efficient. Yep. You're focused on companies. You mentioned a few at the top that you've been visiting that really maybe don't have the attention,
aren't in the press. So maybe there's a little dislocation in terms of their price and what people understand about what they do. So that's what you got when visiting. I think that applies more on the short side than on the long side in the sense that our short strategy then a to go when we were running around New York together and now is I'm trying to find companies that will fail and the stock price will go well
below a dollar a share. Yeah. Yeah. Okay. So you have such great stories and I do want to touch on the book a little bit. You started your career and this was kind of a formative time.
You came out of college. I'm going to age you here. You came out of college in '83, was Was it? Yeah. So you worked for an investment, the biggest bank in Texas,
Commerce Bank, right? Yep. Yep. We had a huge amount of money in our trust department. And so we had five analysts, and I pretty quickly started managing, literally 150 million.
Hey. Right. 40 years later, I'm still managing 180 million dollars. But there was a formative time because what was happening in Texas at that time? Well, Texas was unraveled in the 80s and there's,
I'm so old, I think very few people remember the price of oil drop from 40, 50 to below 10 and companies failed and real,
especially not only did the companies energy stocks and their go bankrupt, but we also had a debacle in real estate across the state of Texas,
which was then more energy dependent than it is now. And, you know, I learned a couple of things, which is one, commodity businesses are terrible business to be in, if you're trying to start a new company,
whatever you're doing. And secondly, lending money is one of the dumbest in the company ideas because it's such commodity. So I've ever since then, I never owned a bank stock my entire life.
I just think it's foolhardy, everybody, and so, but that's what happened. I mean, it's not exaggeration, unemployment in the Metro Houston area, I'm sure went double digit from almost 2%.
And so, you know, it's kind of an eye opener when you're a young kid to see people all around you getting fired and you want to do yourself are gonna get fired. And that was a long time ago,
but it was an education, you know? That was, certainly I learned more from that than I did getting my MBA. - Okay, and that's where you started to get out and meet with companies,
right? - Yep. - Yeah. - On the theory that, you know, it's one thing to read about a company, but you really need to go meet the decision makers to get a grip around. Do they understand who their customers are?
Do they understand who their competitors competitors are. What is their attitude towards capital allocation? You know, if they make money will they pay dividends or maybe do share buybacks or maybe reinvest in their business?
Just where are they going with the cash flow of the business? And then lastly, I try to get my arms around Wall Street coverage of the companies. Yeah, that's where I learned that you just can't substitute company meetings for a lot of reading.
You gotta do both, I would argue. - Yeah, so you had a, from there you went to GT Capital. - I followed my boss at the top, back to the Bay Area where I'd gone to college undergrad.
And I ran a mutual fund only for slightly less than four years, did quite well. And the encouragement of a couple of hedge funds who are both long retired and both investors in my fund 33 years later,
started a little fund, and at my peak, again, I've never marketed. Goldman Sachs is my prime broker, I refuse to go to cap reconverses, I've never managed one penny of pension or endowment money,
and that's how these billion -dollar funds become billion -dollar funds. We're getting just giant investments from the CalPERS, the CalSTRS, the Texas teachers, There were tax funds,
ill state of Illinois, and so, you know, we just, I just managed money for a lot of wealthy individuals then and now, and it's still a lot of fun compounded or after all fees at a slightly north of 11 % a year didn't and still doing it.
So yeah. You launched in 1990. I mean, you're, I mean, there's so many ways you're such a, you're just such a contrarian in terms of how you think, but also how you run the fund. And I don't know a lot of hedge fund managers that have been around since 1990.
So that's a real, yeah, a lot of, that's a testament to you and how you've run the business. - Well, it's 'cause I love doing it. Other guys are good for the wrong reasons. They do it because they want to get rich. - Right,
and that's where they grow the assets. - They want to build a quote, you know, organization. I once had a now long retired hedge fund managers who said, beware of the money manager who talks about building a business.
Yeah, at the end of the day, you want to invest with guys or gals who, you know, I have a small support staff, and they're so excited about their investment ideas, they couldn't give a rip about building a business,
a, you know, I was literally both laughed and cried when I said saw that Bill Ackman is going to bring his hedge fund public. Yeah, I - I think the movie about Shorty and Herbalife is one of the greatest movies I've ever seen about this business,
betting on, what's called betting on zero. - Yep. - But I mean, I just think it's tragic. Bringing a hedge fund public is bad enough, these guys raised money in Europe. Why? I don't know,
because I guess running to 800 millions not enough for Bill Ackman. I guess he's gotta run eight billion. - Right. - But I don't have a lot of respect for guys like that. - All right. Well, yeah, you do comment in the book, to point out some things about the industry,
before we move on, your time at the Mutual Fund showed you some things of what was wrong with the Mutual Fund industry too. Yeah. All they want to do is grow assets. Right. That's how they're paid.
That was bad enough, but the way they would do it, you know, with, you know, giving trips to Hawaii and pens to brokers who jam their clients into the fund and the Mutual Fund industry It's really a severe,
oh, it's in decline, it'll never come back in my opinion. The vast majority of mutual funds help, probably 99 % have underperformed their respective indexes if you look over any great period of time.
And part of the problem is that they're all marketing companies. As Mr. Bogle said, salesmanship at those firms is definitely overridden the notion of being a steward of the client's mind.
So I want to get into this because, you know, you wrote this book, and I want to ask, because you came up with six mistakes you look for, and we're going to-- well, let me list them, and then we're going to ask.
So you look for an each -in, and I want to ask how you came up with these categories, because you say, first, recent past historical myopia, relying too heavily on a formula,
misreading or alienating customers, falling victim to mania, failing to adapt to tectonic shifts, and then physically and emotionally being removed.
So how did, was this just after time you realized, looking back, these were categories that companies fell into, and I know some may fall into multiple categories,
but how'd you come up with this list? That was a decade ago, so the fun 23 years old than that now and the reason I wrote the book as you know as I was lecturing at Berkeley and the professor said Oh,
this these stories are great. You should write a book and of course he had a journalism fellow who needed works And who to this day works for me how crazy is that just yeah for me to this very day Yeah,
Jesse Powell who's credited on great guy. He does all my computer screening. We meet once a quarter Anyway, I look at all the companies. We've been short that had gone bankrupt and at the time there was about 200 plus today.
It's almost 280 I mean, you know, we short stocks that are usually at a 52 -week low with serious problems of the balance sheet So I look back at all these companies that had failed and it hit me that they all kind of made the same strategic mistakes The first one's the most classical on a wall people look at the recent past and assume,
you know Like Home prices are, you know, people thought up until, await the debacle of '08, that home prices, you know, if they ever drop 10%, you wanna buy 'em because they've never dropped 12 or 15.
Well, actually, there are periods in American history where home prices lost half their value. But you have to go way back to the Great Depression. And the other ones as well,
I mean, manias, I mean, we're, you know, we know it's a mania after the fact, you know, people love to be captivated by something sexy. And, you know,
I remember digital learning 15 years ago. Of course, today, the biggest question of all is artificial intelligence. It's not a mania. It's certainly going to transform society, but make no mistake, there will be a handful of winners and a lot larger number of losers.
And because everybody says, well, we're going to be AI. Well, that's not how the company began. So, these six characteristics all applied to one or more of the companies that I had been short that had gone bankrupt.
Okay. And they all made one of the six mistakes, some made multiple. Yeah. You removed from your, I mean, you know, absentee CEOs and CFOs,
I've never seen it work. Okay. So, let's, yeah, let's talk to us about some of these that you mentioned in the book. So, This is a famous one that you're talking here about J. C. Penny. Yep. And I'm Johnson We're talking about Bill Ackman,
so yeah, was Ron John Ackman was on the board was Ron Johnson this if I don't care I'm not big on alumni garbage, but I this is interesting that you mentioned this So literally literally just yesterday morning,
I was in the office of the chief financial officer of Nordstrom Nordstrom and she's super smart and she worked at Target up in Minneapolis for a while and I said hey did you run across Ron Johnson at Target from Target up in Minneapolis he became famous for running apples retail stores and of course he famously went the board convinced him to run JCPenney's and that was a disaster and he was fired in about a year
and a half and the current chief financial officer of Nordstrom yesterday morning in her office in downtown Seattle said to me, you know, Ron Johnson, you mean the guy that fired all of his customers and didn't even move to Dallas to change the work in the corporate office like that's the same one.
So yeah, it's, you know, you bring in a CEO who's a savant and if he's not even willing to move to the city and work in the offices where the bulk of the employees are, you're never going to change the culture.
And you know, his tenure was He was only at pennies like two years and he made some really bad decisions, but worst of all is he didn't even live there. Right. So you've got to be all in when you decide to be the CEO of a company and that part of being all in is you're willing to work and live in the city where the company's head corner.
Right. Another one I think with the building materials, holding company. Yeah, that guy lived, worked out of the tallest building, I don't know how well you know San Francisco, but the Maritime,
not the Maritime Plaza, he was in the, across the street. Can't believe I'm drawing a blank. You know, he had a penthouse view of the water. And when you're running a building materials corp,
which is warehouses that sell lumber and building materials, his office should overlook one of the lumber yards. He should be in the middle of a lumber yard. He should be bumping in the guys in the morning in the evening who are be hauling the lumber and taking it to the customer site.
You can't run a company like that being on the 57th floor of a high rise in New York or San Francisco. I mean, you can, but your odds of being successful drop significantly. Right. So here's another category.
And again, this is a name people are going to know well. Failing to adapt to tectonic shifts, the famous one is Blockbuster, I guess. And then back in the day, they were still around. But I don't know if people remember that they had an opportunity to really pivot,
and they didn't. Well, they came close. At Blockbuster, I was short and went bankrupt. Blockbuster was based in Dallas. They had-- because I haven't reread my book in about four years.
At the peak, they had, I don't know, 4 ,500. They had more than that. A lot of stores, and Netflix was just starting in San Jose, California. and I went to visit Netflix in its early days,
just like I went to Blockbuster three or four times. - Okay. - And Blockbuster literally had an idea, which was you could order the DVD disc online and then drop it off at the store or pick the disc up at the store if that's after ordering it online.
I don't even think I put this in the book. You know, at one point, Blockbuster was an inch away from buying Netflix but they decided not to because they thought that it was a flash of the pan idea so talk about what their strategy what they decided to do instead of just running videos because it became pretty obvious that you could eat you know a DVD disc in the mail and then also digital downloading of movies was
coming online was happening and they are like well let's start selling junk in our stores like popcorn and jujubes and yeah it was just nuts.
I'm like the world is rapidly transforming itself and you're gonna you know offset your revenue client from renting videos with selling gigas that you would get at a Cineplex.
It was just stupid you know what they had to do I don't know if I could have done it but they sort should have closed all their bricks and mortar. A media. Go straight head -to -head with Netflix. - Right. - You know,
that's so hard, easy for me to sit here. - Sure. I had so many stores at the time and you get entrenched. It's, right, it's easy for an outsider, but still. - Right now as we talk, the cable industry is going away.
There's nobody under the age of 40 will ever pay a cable bill in his or her life, right? If you're one of these cable companies, you're facing this really difficult decision. Do we just shut down our cable operations and try to be all about selling,
you know, applying internet. Do we try to have our own streaming service? I mean, there are so many things that the cable world is trying to deal with, but instead they're doing what I think is the dumbest thing of all is they're raising price on the few idiots who still have cable into their own.
And I am one of them. Me too, Scott. But we're over 40, so I guess that's the issue. That industry is dramatically transforming itself and it's difficult,
change is very difficult, but you know, you have to, in Silicon Valley, they famously, they quote unquote like to, you know, consume their cash cows, they'll put their own cash cows out of business if that's what it takes.
Yeah. Another example you had was the Yellow Pages, which surprisingly still in the early 2000s was, was a business, a public company, and existed.
And they thought, well, yeah, tell me what happened there. - The Yellow Pages. So I physically went to meet with management, the CEO of a company called Idear Arc,
and then they changed her name to protect the innocent. They were a Yellow Pages company, one of the two. And it's one thing to do the Yellow Pages, but they had a lot of debt on their balance sheet. And I remember saying to the then CEO in his office,
I'm like, what's going to happen in the next five to ten years? He goes, oh, there'll always be people in America who use the L pages. You're not going to get a 40 or 50 year old to start looking things up on his phone.
I'm like, well, I said, one, they will. And two, I'd rather cater to 20 year olds and 50 year olds because 50 year olds are on the verge of dying, right? I mean, in 20 year olds,
they're going to be around for 40 years. So you're catering to a customer segment that's on its way out. I mean, truly on its way out. But I've thought about that in the last two to three years.
The core mistake at the yellow pages, and there were three or four public trading yellow pages, they all went to zero, by the way. They went bankrupt, went to zero. They had too much debt on their balance sheet.
And so today, I see a similar problem with a famous industry that only has two public companies, and that's the two companies that own movie theaters.
The world is changing. Will there always be movie theaters? This is a fun discussion to have with a bottle of wine. There might be, there might be art theaters, there might be, there are some people who want to go to the Metroplex in Kansas City,
but there's also a chunk of the population that's going to prefer to have that movie straight on their TV screen at home for price. You probably would rather pay 20 bucks to sit at home with a cheeseburger or a prime steak and watch a new movie than to slept to the theater and sit in somebody's seat that's coated with greasy popcorn,
right? So, Sid Markendallis and Ames, which is super controversial and noisy in Kansas City. - Well, that's a meme stock too. - That's a meme stock. But those companies,
I think they're going to have to radically pivot part of the problem with both is their balance sheets are terrible. They have too much debt. I suspect both will end up at zero. AMC has raised so much money because every time the meme stocks spot,
that guy is least smart enough to know, I got to sell all the stock I can, raise as much money as I can because I have so much debt. The Cynmarx guys also have a lot of debt. But again, I'm getting back to a huge Epic change in society and not going to the movie theater watching a first release movie at home That is an epic change But I think the trend is inevitable and it's not like people gonna wake up five
years from now and go You know, I don't want to watch the newest mission impossible here in the comfort of my home I want to go to the sinplex parking lot on a humid day and park You know eight rows back and slide through the theater line.
No way That's a diminishing percent of the population that's going to be willing to do that. Yeah. So both stocks, I think, are short headed to zero is just a question of, are they both going to become meme stocks again?
I'm shocked that AMC started running a month ago. I mean, I think people playing that game know full well, long term stocks is zero. Yeah. So I want to talk to some others because there are so many stories.
This, this is a name that probably nobody knows. This is under the category fell victim to mania. There was this company, Quaca Sports. Quaca Sports. So tell me about Quaca Sports.
This is a, remember when, you know, the America's Cup became all the rage about a decade ago or 15 years. And so people, all the rich, rich This is sailing. Yeah. Yeah. The people who live in Newport and Middle Park and live in San go and live in,
you know, the Upper East Side, like, "Oh, I grew up sailing." Nobody in America gets on a sailboat. Nobody in America is a sailboat racer, okay? I remember one of the Koch brothers was a sailboat racer and an alcoholic,
and then he died from alcoholism. He won the America's Cup right around that time period, neither here or there. But anyway, there was a company in San Francisco, headquartered,
called Kwaka. They came public, I went to the office and that was the chief executive officer in his office is I think on Townsend Street in San Francisco. And I'm like, walk me through this. He goes off people watching Silbo racing on their on their digital device on their laptop or their phone.
That's the future, Scott. I'm like, no, it's not. Nobody gives a crap about yacht racing, except maybe Larry Ellison, and he's appeared up. And I said, this is not a business.
And he's like, oh, no, look how exciting got racing is. I'm like, no, it's not in. And the only people who do that is this slim slice of the upper crust in our country, who also might be disproportionately involved in the money management and Wall Street game.
And so, of course, the Wall Street crowd for a while thought it was a great idea. Right. Anyways, I sure the stock and fire went bankrupt. I mean, it's got the Zero and there's another one now.
You're getting me excited a little more mass market appeal. Remember inline skating Yeah, this okay. This was first team sports, right? Yeah. Yeah, they're really had people telling me. Oh You know people are gonna stop riding road bikes and jogging Every weekend all over America.
You'll see everybody on their inline skates. I'm like, no, that's not gonna happen That's just not going to happen At the moment, it was popular, but I'm like, no, there was a Minneapolis company that sold inline skates,
and it didn't go broke, but they sold out at like a dollar a share three years later when the inline skating craze became a boss. And then there was also biotech, you said biotech's also. Biotech's hard.
But what about it? There was a company, Cygnus? Cygnus Therapeutics. Well, you know, now that one was, there's still hope there. They were going to have a watch that could reach your glucose level. And certainly,
there's a need for that in our society. And rumors are always flying that Apple's going to incorporate that in their next "I watch" iteration. That's an idea that is a good idea.
It was way ahead of its time. The watch didn't work. Right. You tell a funny story about how you went in there. I was shaking the watch around and accidentally hit my arm against the the desk and the thing cracked.
And it's like, oh, he goes, oh, wow, we've got a lot of beta samples. That's okay, I'm thinking, ooh, that's awkward. And the stock went to zero. Yeah, bankrupt. But you were rooting for them.
Yeah, I should say that you note this in the book. A lot of these CEOs, these aren't dumb people. No. These are smart people. But for one reason or another, they're just tied into a certain narrative,
or they're just tied into a certain, they surround themselves with people who are, you know, telling them this is going to work, they're just something that, again, fitting into this category where they're just not seeing what's actually happening in their company.
Yeah, and their own lives is one of living in the upper crust of America, and the upper crust of America has different hobbies and habits that doesn't translate to all of America.
Currently, this is my favorite stock I'm short today called Virgin Galactic. Okay. Oh, this is Branson's? Well, his name's on it. He's a flighty guy. I can't go into,
I don't know the exact detail of his financial involvement. He does have an ownership stake, but I bring it up only for one reason. It might be the dumbest thing I've ever seen in my entire adult life. I mean, this notion that there's going to be a lot of Americans who will willingly plop down $100 ,000.
Now the ticket's $650 ,000 to fly. - Thanks inflation. - So I short the stock at 11, it's 80 cents. They're gonna go bankrupt. But it's not that I'm right,
I'm wrong a lot. It's just that how many people in America have the financial wherewithal or the intellectual interest to get on a spaceship for two hours.
And it's And, you know, how Wall Street always says, "Oh, the total area market, the TAM is blocked." And I think the TAM for space tourism is almost zero,
honestly. And worst of all for them, when you do it once, you don't do it again. It's not like eating a Big Mac. You know, when you eat a Big Mac, you think, or better yet, five guys, which is my favorite upscale burger.
When you eat at five guys, you're like, "God, that's good." And like a week later, "Hey, let's go back to Five Guys." Nobody says, "Hey, let's go back to Blue Origin "or Virgin Atlantic and fly to the edge "of the atmosphere and back." So these things were destined to go to zero the second they got on the screen.
And yet, again, that's a mania and unsustainable one. - Yeah, and then another category, some good ones here where they misread or alienate customers.
- Right. - And then you talk about this company, What you liked a lot was the one you visited, and you had, I think, an infinity four from your childhood, cost plus worldwide. Yeah.
Yeah, they tried to go upscale. They were a deep discounter of imported goods, predominantly from Asia. They started in the San Francisco Bay Area. Their corporate headquarters are over in Oakland,
right underneath the 880, which is still there Broadway. And yeah, I mean, new management came in and instead of trying to find really fascinating,
imported this and that, they started going upscale. A lot of retailers and today a lot of digital retailers do that. And they lose sight of the fact that people love bargain and don't try to,
you know, take what was a treasure hunt experience and turn it into something where they can't find anything that's affordable. - Yeah. - And that's what Cosplus did, the old one broke, but then they were able to,
they did somewhat turn it around. And it was them, you know, it's crazy. Now you're, Steven, you're making me think about it. I think at the end of the day, Cosplus,
world markets, and there's some that are still open. It was bought by Bed Bath and Beyond, wasn't it? - Yes, yes, you just say it in the book. And it was one of these where they, Right, it was new management, I think that came in.
You detail that they lost their way. So there are companies that can get back on track and we'll talk about some others, but you noted that they had gotten back to their knitting after a while. And then eventually,
yeah, I think you shorted them and then wrote it back up. You sold it, you covered and then got it. That's a decade ago and now I'm trying to think of an example of that. There aren't,
I can't off top of my head. But these are strategic mistakes. Money management is not a game of relative valuation in my mind. It's a game of predicting the future. And these notion of paired trades and arbitraging and all this garbage,
I don't do any of that. I'm trying to predict the future. Again, that's why I love this book because there's so much good stuff here. You did talk about there's management that can realize what's going on and turn it around,
and this one goes back to really, there were three companies, I don't know if we'll get to all of them, but this one was, again, very early in your career that you saw Texas Air and Continental, which I didn't know the history back there,
but talk quickly about that. Texas Air and Continental, I was in the book just because at one time, Texas Air Corp was the largest airline in the United States by passengers and available sea miles.
It was an idea from a very aggressive CEO named Frank Lorenzo. He passed away a year ago. And he cobbled together a bunch of airlines that oldsters remember,
youngsters don't like Eastern Airlines, people Express, Frontier, and Tottenham was the mother ship brand. And, you know,
the airline industry has always been through cathartic up and downs. In Texas airs case, like so many other airlines, they ended up with too much debt and ended up going bankrupt. But I owned it when it came out of nowhere 'cause I was visiting management Houston over on Allen Parkway.
And it kind of made sense to me that some segment, Southwest was not gonna own the discount carrier world. There would be other players and that's what Texas did at the niche they filled.
But then they, they liked so many companies ended up borrowing money and borrowing money is the death of every bankruptcy out there other than those that just run out of cash because it's a stupid idea.
That's a long time ago, Steppen. I mean, I know, I know, man, you're going a little bit more recent. There was Zales. You talk about Zales was a company in Dallas or corporate offices were in an office park halfway to DFW from downtown and yeah,
they again brought in new management that reversed the mistake and trends of the previous management. At the end of the day, a low -end jeweler needs to be careful about lending too much money to its low -end customers.
That was one of the mistakes the else management had made. New management turned it around and then they got bought. They're now part of the company based in St. Louis. This was about 15 years ago.
So again, management matters. One of the things I look when I visit companies, I always ask the CEO or the CFO, where'd you come from? Well, yesterday,
the Chief Financial Officer at Northstrom, quite impressive. On top of being at Target during their incredible transformation, she was at Walmart and she lived in Bentonville. I will bet on people like that.
Yeah. And so, Okay, so yeah, let's skip the other one because we're running low on time with it. It was called international gaming tech Yeah, and you had a different view of it and you walk into a casino today and you still hear The wheel of fortune.
Well, that was them. That was them So that was a technological innovation and industry not known for technological innovation, right? And this is going back to 1993 when gaming was just really The gaming was rolling out,
so you had wind at your back, secular ship, you know, gaming was Atlantic City, but then it was starting to roll everywhere, Indian casinos, and the notion that you could walk up to a slot machine and put a nickel or a quarter in and get $10 ,000 because it was linked to 30 other slot machines,
and their most famous slot machine was called, was the Wheel of Fortune machine, and people went nuts for it, and the stock went from like 20 cents a share to $100 a share was crazy.
- Yeah, and you were on that, right? - I was there, and why? Because I would physically go to their headquarters at their offices about a mile south of the Reno Airport,
beautiful building, and I met with Tom Baker, he was CFO at the time, long gone. He's like, no, we're a tech company. you know,
building crappy slot machines. And on top of, we want to have a product that's sexy and attractive. And there was a time, not that long ago in this country, where a slot floor anywhere in America would be 100 % international game technology slots.
Now today, they're distant, I think third. So they've lost their lead. But 25 years ago, you go into a slot floor like the Mirage or Treasure Island when it first opened,
I bet you those two casinos when they first opened were 100 % international game technology product because they were simply better. They had a higher win per slot per day than everyone else. Yeah.
Yeah. So I want to talk about when you go visit companies and I want to ask you, has it changed? Is it hard to, even though these are smaller companies, how do you call up, you know, again,
you're a small, you know, hedge fund manager. And again, I would say this is rare because most people think hedge fund manager are behind a Bloomberg screen and looking at the financials of a company and then determining,
okay, we're gonna invest based on EBITDA and all these other terms. But you go and visit them. So what do you say when you're going in and what are the visits like and how's it changed over the past 10 years?
Well, we own 45 stocks, 50 stocks for short 70 to 100. First thing I tell management is, hey, we try to own stocks for one to two to three years.
I also am very upfront. We also short stocks, but our short strategy is probably different than almost everybody you meet or read about. We're looking for stocks and companies that are probably headed to bankruptcy and the stocks are probably $6,
$7, $8 a share. And I rarely short stocks that are $30, $40, $50 a share. I never short valuation, ever. That's death. I also say, but we have,
like today as we look at each other, I've got about $175 million in longs and about $50 million in shorts. And I always tell the CFO, hey,
we wanna walk out of here in an hour knowing you have a firm understanding of your customers, your competitors, your capital allocation is targets, but also what strategic changes might happen here?
Are you gonna grow shrink? Are you gonna international, folks domestic? Whatever you do, I'm gonna get my arms around, will this management team be able to generate growing top and growing bottom line?
And then what will they do with that cash? And on the long side, I'll visit 100 companies a year and only make 10 in any given year, you know, most companies don't check all the boxes,
right? They may know their customers in there and they may have a leg up in their competitors, but they may have a bad capital allocation strategy or, you know, on and on and on. And on the short, you know, so I every single stock I own,
I have physically been to the offices of the company, every single one on the short side, that's not the case. Probably a third of the shorts I've been to two thirds, I may have missed him in a conference or I've talked to him like I I've never been to Virgin Galactic's offices Yeah,
I think I need to go to Virgin Galactic's offices to conclude that that is literally the dumbest idea I have ever seen for so many reasons and of course and I don't want to get morbid on you,
but I'm a morbid guy But you know when that little sub blew up when it went under lock like all we take is one virgin galactic to blow up in The sky and that stock will probably not open up the next day.
- Yeah, I was thinking of that when you brought them up, right? - Yeah. - So that's how I do it, and that's why I do it. And you know what, I'm the luckiest guy on earth, 'cause you know what? These are really, generally, but few notable exceptions that people who run our public companies are pretty smart and pretty hard working.
I bet you the guy who runs Virgin Galactic really believes that's an industry. Now, he's dead wrong, but he's not a shyster. He's not a crookster. He's just wrong and you sent me an email yesterday and I've repeated this again and again Again,
there are three types of shorts. There are fads. They're fun to talk about We just talked about a couple of them first team of sports. We talked about quaca. We talked about rods Well,
they're the ones get all the press and Ron, you know more recently We've had that wire card in Germany, you know, every year there are two to three Frauds frauds, whether it's financial fraud,
it's accounting fraud, it's, and then of course over here just good old fashioned failures. Companies that just can't make interest payments, and so they have to radically restructure usually through the bankruptcy code,
or they just run out of cash because it was never much of a business. And today, you know, well, year to day we're having a pretty good year, but that's our longs, we're up about 25 million and our longs were up a couple of million on our shorts.
But with all these facts that came public in the last two years, and these are companies that they're blind pools that bought operating businesses, there's a whole new, there's a plethora,
2 ,000 plus new ticker symbols. And you know what, most of them are gonna end up at zero. Yeah, 'cause you do this very good defense of short selling in the book. And for our listeners who don't know,
you say A short selling is good for the health of financial markets, so just explain why that is. If we short a stock, if the stock starts to go down,
you know, shorts, by the way, there's always this thing as a short raid, you have to get an uptick to short a stock. So you can't just keep knocking the bid as you're selling it, but short sellers generally do financial markets a favor by trying to bring the light both through our actions as well as when we talk to other people,
though I don't talk to the press, that certain companies might be excessively valued, might be headed towards a crumbier future, and that, you know, in a way, we are hopefully making it,
making the loss if John C. Public buys that story or that overlevered company stock, he loses less than he otherwise might lose. I'm not a fan of a lot of my fellow short sellers who create stories that simply aren't true,
that have their own podcasts or they're, you know, I'm not on social media. You're not an activist short seller. Oh no, no, no, no, no. I've met some of them and they do really good work. I mean,
Hindenburg, I don't even know who Hindenburg works for. He's in Manhattan, but he's been writing like every single time in the last three. So these are guys who, they do three to ten activist a year where they they short the stock or that in Hineberg's case,
we think he's working for Big New York Hedge Fund. Nobody knows. I think people know, of course they do, but I don't. And then he says, he puts out like a 20 pages report on the internet. He goes, I'm short this stock and here are the 37 reasons why.
That's what Ackman tried to do with Herbalife. Okay. Right. Right. And let me make a statement. I have the utmost respect when people go that deep. And by the way, Herbalife is a horrible company that deserves to be at zero.
And shame on this guy, Carl Icahn, is he just a greedy bastard? I mean, how could anybody defend Herbalife? I'm not saying you got to be short the stock, but I bring it back because, you know, I kind of badmouthed Mr.
Acklin, who I've never met earlier. But I have tremendous respect for somebody who does a thorough short report and tells, tries to tell the world why you don't want to own the stock. He, you know, by the way, Herbalife, I think is like a three or $4 stock today.
It's clearly finally, you know, it's going to die Finally, everything about that company is literally reprehensible, selling a product that does nothing, doing it through multi -layer marketing with third world poor people who just want to have a better life.
Shame on verbal life, right? Yeah, that's a trifecta right there. Oh, it's everything bad all in one company. Yeah. Scott, I also want to say you own it too because you talk about your own failures,
you talk about your failures in investing, you talk about 2009 and you have some self -reflection and say, you know, you talk about being holding to formulas. I don't know if we got into the companies there,
but you say that, you know, obviously we're coming out of the global financial crisis and you probably thought that a lot of companies were going to zero because of what was happening. So you own that,
but you also, you own a restaurant, but so, which is, again, you talk about failure, that's a high failure rate. And just talk about the first restaurant you had.
Well, as Mudbugs won, the name was a bad name to begin with. Okay. Now, McDonald's does all this statistical, you know, sampling and consumer -focused groups,
and I said, "Hey, I want to do a Cajun restaurant, and an affectionate name fish is a mud bug. And of course, if I had to talk to 45 people or they're California,
you know what a mud bug is, they're discussing, is that a cockroach? Is that a beetle? So that was mistake number one. Mistake number two is you want to sell product to people that something that they know and like and,
you know, trying to sell Cajun food in Northern California, specifically in a lily white community like Marin County, just didn't fit with the customers and be like,
you know, you're not going to drop a vegan restaurant in some, you know, place where people, yeah, I just miss, I didn't talk to my customers before the idea began. So I lost a healthy amount of money,
all my own money, no outside investors. The second one has worked, but that's because it's in Berkeley. I tried it again because I, you know, I like to, I like to hate myself, but that would work for two reasons.
We're in Berkeley, It's a diverse community a lot of black and brown people university related people They'll try adventure some ethnic food Secondly more important than that is the general manager is awesome and yeah people matter There's anything through the decades I've learned is that people really matter and you don't know a person until you spend an hour or two with them Yeah,
that's just can't read what they you can't read his conference called transcript and say, "Oh, this is a super smart CEO." You gotta go there and ask them questions and see how quickly they respond and see how reflective and insightful they are.
And I feel that way about everything. I feel that way about politicians. I don't, it's hard for me to have a hard opinion about somebody who I've never met. - Yeah, and what's the name of the successful restaurant that you have?
- Oh, thank you. The world doesn't need to go. It's a static Boulevard, one block from the University of California at Berkeley campus is called Angeline's Louisiana Kitchen. We're on our 18th year.
Awesome. And we've recouped our roughly 400 ,000 open, another 400 ,000 to expand. We've recouped that multiple times over, down to a 47 % ownership. I keep giving ownership to the chef of the gym because they're making it happen.
And I'm never there. But it's worked. But The last two to three years, we barely made money, because the restaurant industry is facing, talk about an industry that's facing an upheaval. The restaurant industry,
labor costs are spiking, and successful restaurants, I think, are gonna have to pivot the service model, and part of the pivot is you're gonna have to get labor out of your restaurant. And California labor is gonna,
we're already paying 18, 19 minimum wages going up, nationwide, maybe it should, right? I mean, I've has been kind of a liberal on that issue. But that means that restaurants that are labor heavy might fail.
I don't know if you saw, I don't know how much time you spent in California. Very popular fast foods chain filed bankruptcy yesterday called Rubio's. The whole chain, they had over a hundred fast food units in the state of California and a few in Nevada and Arizona.
And they, a week ago, roughly closed all their Northern California units and all their Sacramento units. And then yesterday they filed bankruptcy. The labor issue in America is going to be the death nail of labor -intensive restaurants.
So the model's gonna have to change. You're gonna have to have QR codes instead of servers. There are a lot of things you can do to change, but to not change, you just have your head in the sand, you're gonna see more bankruptcies in the restaurants. And so yeah,
Angelique, Louisiana kid. (laughs) - Well, that's 18 years, that is amazing. That's, again, a rarity in the restaurant business. So congratulations on that. I also want to give a shout,
'cause, you know, way back, I don't know if I can take credit for this one, but there was a nice article about you, an institutional investor, and, you know, all the proceeds that, for your book, went to a school that you helped build called the Oak Hill School.
- Well, the book lost money and that's, I get the book. - So the kid's got no money? - No, don't worry about that. - No, you're funding this, I'm kidding. - Because that actually is more important than anything I've talked about.
So this is a school for intellectually disabled kids. The bulk of them are on the autism spectrum. Some are just my own son. You know, of course, it always is something that touches you. My own son is diminished intellectually.
I have three kids and one you know, bad, bad luck, right? Believe it or not, we're going into our 24th year. We have 55 kids. It's all called Oak Hill School in San Salmo. All the kids are intellectually disabled to some degree or another.
The school districts pay for 50 and the 50 plus, five plus kids. And yeah, I wrote that in the book. I mean, the book lost money. I paid my friend now, my employee,
my ghost writer. You're telling me I didn't do my job then. We didn't sell enough books. - No, I never, you know, I get a lot of grief. I never promoted the book because I'm kind of like, I'm a nobody, but you know, like,
you know, that famous Boston Money Manager wrote that book, "Margin of Safety." - Yeah, Seth Claremont. - He never promoted it. You can't even get your hands on that book. - I don't know. Well, that's the thing. Maybe we got to get it out of all the books stores and that's because it's scarcity,
right? You can't find it. So now it's-- - Well, he doesn't want people to read his That is, um, oh darn it, he was, he's a legendary Boston. Yeah, Seth Klarman. Seth Klarman. And of course,
um, um, uh, uh, Steinhardt wrote a book called No Bull about 25 years ago. That's a damn good book. And again, Michael Steinhardt never promoted it. He didn't care. He just wanted to write the book,
I guess, for posterity's sake, and that's a must -read. And then another must -read is a book by my, guy was literally in my MBA class in in graduate school, a guy who wrote a book called "Big Money Thinks Small," Joel Tillinghast.
He just retired, he ran the Fidelity Low Price Stock Fund and when he showed up it had like a billion dollars and when he left it had 70 billion or something. More than that, he's generally regarded,
Joel Tillinghast, believe it or not, is generally regarded as the greatest fund manager in Fidelity's history. And they had a very famous person there for a while by the name of Peter Lynch. Yeah, Peter Lynch, right.
And that's a good book too. Peter Lynch's book is quite good, but there are a lot of guys who write books in the investment game and then they just kind of like, "Well, okay, now I go back to my life." Right. So I should say Scott includes books that you've read in your investment letter.
So I'll include some of these on our website and put them up, but that's great. So again,
how many companies - Now have you visited? - Oh, we're north of, we're north of 2 ,500. There are a lot of repeat visits in there. Let me plug the current book I'm reading by Gretchen Morgenstern. You probably have looked at it called These Are the Plunderers.
- Yeah, yeah. - That is a great book. And you had Rob Colpin on. I finished his book last month about Ray Dalio. - Yeah, great book. - That's a good book too. - Did you watch my interview with him?
- I have, So all I'm going to do for the next 48 hours is watch. And the school, Oak Hill, I'm fair. I give away to Emerson what I make, the book at the book.
So you don't have to worry about Oak Hill needing donations. I'm taking care of that. No, it's just a great thing that you can do. And I appreciate you taking the time, Scott. Thanks. It was such a good book. And again,
I think it has lessons for CEOs who are in the middle of the run their business would benefit from reading investors. - Yep. - Anyone would benefit. So whether you're starting out,
it's not a book about short selling, although, you know, there's a good defense of it there. So it takes quite a while. - There's a lot in there for just about, don't make these same mistakes. - Right, exactly. - Really, just these are mistakes that others made, let's learn from them,
right? I learn from them, I make a lot of mistakes, so yeah. - And you own it. - That's your time on Read the Bull. I want to thank you. It's dead companies walking. - Thank Thank you, Staben.