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10 Cents on the Dollar | Gary Mishuris on Mispriced Fear and Lessons from Warner Brothers
01:03:25
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- [00:00]
Gary Mashuris
At one point during lunch, Keeler turned to me and said, just cheap doesn't work. And I'm like, what, what did you just say? You know, like, he just basically like, you know, put a hammer to my, my whole like, you know, treasure chest of beliefs there. Buffett gives away all his secrets. How many Buffets are there, you know, people with Buffett like returns? I mean, not to get into this tangent, but there are plenty of people claiming to try to clone Buffett. No one has succeeded so far as far as I know. The trick is in implementation. Just think of you have a good company that's a division and it's earning $2 a share in a bad company, losing a dollar a share. Combined company is making a dollar a share and the market is like, let's put a multiple of that, let's say 15 times. The whole thing traded 15 times. Even though you could shut down the money losing business and have $2 of earnings and you know, the stock would rewrite fairly quickly.
- [00:58]
Matt Zigler
You're watching Excess Returns, the channel that makes complex investing ideas simple enough to actually use, where better questions lead to better portfolios. Our guest today, Gary Mashuris, CFA Managing Partner, Chief Investment Officer of Silver Ring Value Partners. He's an MIT trained investor known for combining rigorous intrinsic value analysis with behavioral finance insights. And his North Stars always compound capital over the long term. He teaches the Value Investing seminar at Babson's College F.W. olin Graduate School of Business. He writes Behavioral Value Investor on Substack, where he explores this intersection of classical value and cutting edge AI enhanced research. And this is all part of why I wanted to get this guy who's come all the way from the Soviet Union originally to leading a disciplined investment firm. And the takes he's got, takes not the least of which this Warner Brothers one that we're going to dig in today. So long time coming. Gary Mashuris, welcome to Access Returns.
- [01:54]
Gary Mashuris
Well, thank you so much for having me. Really looking forward to a conversation.
- [01:57]
Matt Zigler
Well, us two, I brought Bogomil with me. We're going to tag team this effort. And again, you wrote this beautiful note, series of notes on the Warner Brothers merger. We're going to get up to that stuff, but I want to start here. I want to start with your learning at Fidelity in the Peter lynch era. You were there in what, 2001, this, this shape. Can you, can you just, you had a rare experience in history. Can we start with that real quick? What was it like at Fidelity in 2001?
- [02:24]
Gary Mashuris
Yeah, absolutely. And I, you know, So I was. I just graduated from MIT when I started my investing journey, when Buffett came and spoke on campus at the Sloan School, right during the tech bubble. And then for some reason, I have no idea why Fidelity hired me. There was like 3,000 resumes and there was seven associates that year. And I was sure when the director of research called that it was a mistake. And I actually almost turned them down because I was so, you know, I. My father passed away at a young age. I was, you know, my mother's only child, you know, so I had my heart set on coming back to New York. So I'm like, you know, I. I'll interview with Fidelity. It has. It's like the home of all time great investors, but I'm probably not going to really take it, even if I get it. But he persuaded me. He said, hey, listen, we'll pay you, you can fly, visit your mom as much as you want. So I said yes, and I started. And it was an incredible time because this was a time when you think about the heyday of Fidelity, it was probably when Peter lynch and Bruce Johnson were the two pillars. One on the kind of a more on the growth side, the other more on the value side. So those days were kind of behind us at that point. You know, Peter was still a vice chairman. He was a mentor. You know, I had the privilege of, you know, meeting him a couple of times and talking with him. But by and large, it was the next generation of investors. And just as I joined the market, you know, bubble started to pop and stocks started to collapse. It was definitely a very interesting time.
- [03:56]
Bogomil
What a time. And I asked my guests on Talking Billions about those early days, especially when they started investing, because I think that shapes us. I'll mention about Peter lynch, and you both know that the reason why I'm here talking to you guys about investing today is Peter Lynch. I picked up his book One up on Wall street when I was a kid. My studies in Brussels, and that book, One up on Wall street, completely changed my life. So for you to work in his shadow, see him, talk to him, I mean, I would have been blown away at 20 if you told me that's even possible.
- [04:26]
Gary Mashuris
Yeah, no, it's completely incredible. His eyes. So we as young associates were given the privilege of, like, a small group lunch with Peter. And I read both books. So Beating the Street One up on Wall Street. I read them core to core in preparation for that lunch. Because, you know you're going to have this chance to, like, meet a living legend and ask him questions, right? So you have, you can't blow it, you know. And so, you know, it was incredible just because, you know, the guy was just so incisive and he would just got to the chase so quickly. And I remember, you know, he really hurt my feelings a little bit. Not on a personal level, but I kind of was a very much of a classical value investor back then. Ben Grah, you know, Benjamin Graham, that kind of stuff. And you know, I forget what my question was, but at one point during lunch, Keeler turned to me and said, just, cheap doesn't work. And I'm like, what, what did you just say? You know, like he just basically like, you know, the hammer to my, my whole like, you know, treasure chest of beliefs there, right? And I kind of immediately, like, I bristled and I was like, wait, but Joel. So Joel Tillinghast, who kind of was one of the hires that Peter brought on, was someone I have considered a mentor my entire 25 year career, you know, But Joel does it, it works for him. He's like, yeah, you know, I guess, you know, the way Joel does it, it works. But just remember, just cheap, like low price to books. And like, I just, it doesn't work. And again, took me many years to really internalize that lesson. But like, little nuggets like that, they were priceless, you know, or even, you know, Will Danoff, who was one of the portfolio assistants on Magellan under Peter lynch and who is, was, you know, Joel. I would consider Joel at the time was there and Will were the two kind of master, like legendary investors there. And Will Danov, who runs the Contra Fund, is an amazing growth investor. He would ask these crazy questions. So he would come to meetings, for instance, we were all allowed to come to company meetings. His hair would be all messed up. He'd have the stack of papers walk in 10 minutes late. If you didn't know who he was, you'd be like, hey, did this guy just walk off the street? What's going on? Who is this guy? And he would interrupt, he's like, wait, guys, what do you guys do again? And it's like, oh, no. You know, the Analyst has like 25 questions, perfectly structured with sub bullet points, like, what are you guys doing here? And he's like. And the CEO, of course would answer Will's question because he managed a lot of money, was very, you know, had a very strong reputation. And I said, well, yeah, but the last guy I talked to, you know, he said, you also did this. And the CEO be like, well, this is a little awkward, but that CEO passed away, you know. Yeah, but he said you have these stupid saddle conversations, but they were not stupid at all. I mean, Will was just as skilled as Peter was at, like, getting to the heart. What do you do? How do you make money? What makes you a good business? What's changing for the better? What's changing for the worse? So, anyway, we can talk for hours, and I don't want to have a runaway train here, but it certainly was an amazing experience.
- [07:33]
Bogomil
We'll come back to the questions down the road. What kind of questions make a difference? I want to ask you about the certain story that you shared with me. And maybe this audience knows, maybe they don't, but I think they should. Silver ring, the name of the company.
- [07:44]
Gary Mashuris
Yeah.
- [07:45]
Bogomil
It has a story behind. And if you tell the story, I think we'll learn more about your journey to the US and also the appreciation of what has value, what has price in life.
- [07:55]
Gary Mashuris
Yeah, no, absolutely. And I teach my seminar. I always tell my students, when you assess an investor and you try to learn from them, you want to understand the context, like their life story, like, how did they become who they are? So for me, so my family is Jewish. You know, we left the former Soviet Union. It was 89. And back then, you couldn't just go straight to the United States. You had to go to a Western power. So we stayed three weeks in Austria and five months in Italy. And the. The Soviet. The Russians weren't very friendly to us. You know, like, they said, okay, you're limited to $125 per person of cash you can take, which is not a whole lot. And then they said, well, we don't want you to take your money and buy up a bunch of jewelry, a bunch of watches, what have you. So you're limited to one item per person, like one ring, one watch, whatnot. So when I was a little kid, my mom gave me a little gold ring. Now, like, that used to be hers in childhood, but we couldn't take it because it was my mother and my grandmother and I, and it was the three of us. So we going to take the three more valuable rings if that's all we could bring. Right. And so here we are in Italy, and the way immigrants made money, there was a bazaar marketplace, and you sold off your belongings. There were charity organizations that helped you along the way, but you needed more money, so you would sell things off. And I specialized in these commemorative matches where the Italians love the Russian stickers with the wooden matches. And that was my. I cornered that market. I made my first, you know, seed capital of $35 at the tender age of 10. But then, you know, I made all that money and I was. Kept walking past this jewelry store and I saw this gold ring, you know, and I said, I'm like, wow, it looks like just like the ring I had to leave behind because we couldn't take it that my mom gave me. And so I got my mom's permission. She wasn't thrilled because, you know, so it was 5 mil at the time. So this is before the euro. So a mil is a thou. A thousand lir, which was roughly equivalent of a mil was like 70 cents back then. So this was like $3.50. I'm a kid. I don't know what the exact cost, right? So I see this gold ring, it's 5 mil. All the other gold rings are like 40 mil, 50 mil, 100 mil, you know, but this ring is like. Well, like it's a little smaller. So I'm coming up with a story with this narrative for why it's such a great deal and I can restore my kind of, you know, the equivalent of my heirloom buy this ring. And of course I find out very quickly why it's so cheap because, you know, over the next couple of weeks, the gold wears off and, you know, turns out it was a silver, you know, just gold plated. And not very well at that. Now, I don't think the store was like trying to defraud me probably. There was probably something in Italian that said gold plated. They just didn't speak much Italian. But that story really kind of had a few lessons for me. One is like, cheapness, like kind of a surface cheapness is just not enough. It's not a. It's not necessarily a marker of value. It's maybe a sign to investigate. It's not the conclusion. And then also just that you have to do your research. Like, if something is, you know, too good to be true, potentially, like, it might just be just too good to be true. And you need to dig deeper and find out what's underneath that gold plating, you know, if you will.
- [11:10]
Bogomil
Phenomenal story. I. Yeah, I. Every time I hear it, it gives me chills. And I'll just mention. And I know Matt has many more, but I grew up in Cold War Poland. We're close in age, so a lot of the stories that you share I can relate to. But I don't want to take over this conversation anyways. This is a beautiful Story that made me tear up when you shared it the first time.
- [11:29]
Matt Zigler
It's a beautiful story and I love these principles that are inside of you. Like, I love that you can reflect back on this. So I want to take you to the piece that's the real reason, quote unquote, that we're here today. And I have to say, reading this and following this in real time, this made me think of reading about the yahoo deal, whatever, 10 years ago when they owned a piece of Alibaba still. And it was just. It was so rough. So you write this substack article, Warner Brothers how five mental models turned a hated stock into a 3.3x opportunity. And we don't. There's just not a lot of studies about stuff like this. So I want to start here. You open with. It felt lonely owning Warner Brothers. And I know you got. You got the kick. Crap kicked out of you for a while. For a while with this thing.
- [12:18]
Gary Mashuris
Take.
- [12:19]
Matt Zigler
Take me back to that. And let's talk about maintaining conviction. Like, how'd you do it, man?
- [12:25]
Gary Mashuris
Yeah, you know, I think, well, I'll get to how you do it, because it's not easy, you know, but it's also. You have. Well, I'll just start there. Why not? I think in general, you have to be wired not to be a contrarian. Consciously, like, hey, I'm going to be opposite whatever everyone else is saying. You have to just be wired to think from first principles and have the temperament to ignore the crowd. But we'll come back to that. So I think Warner Brothers. So I have a long history of the company. I made some money in an investment in the past. I've held it for a number of years. Then this merger happened. For those of you who don't know, basically Discovery Communication bought Warner Brothers from AT&T. And this is like the assets they bought were storied assets. Warner Studios, hbo, the library, Harry Potter, all of this stuff, the HBO library. And the idea is they're going to merge together. They're going to get scale because John Malone, who's on the board, who's kind of the mentor behind the CEO of Discovery, David Zaslav. John Malone was a big believer in scale. He's talked about the media landscape and how Netflix has the scale, Disney maybe has the scale nobody else has global scale. You needed to compete. So that was kind of his vision that you thought Discovery was subscale. Let's put these assets together, create a global competitor. Well, you know, like, this was like the one of, you know, maybe not the worst merger in history. But it felt like the top 10. You know, if you guys all remember AOL Time Warner, the original deal, you know, kind of, you know, the slap back slapping on stage, you know, that quickly turned into the biggest write off in history. This was kind of in the running for, you know, top 10 in that regard. Because no, they opened, you know, they did the due diligence and as soon as they came in, turned out like a couple of billion of profits they thought were there were not there. Things were worse. All these. It got so bad that at one of the annual meetings with Discovery, there was this woman, Gaslight, kind of like, like almost screaming at Zaslav, like why you get paid so much. This is the worst. This is like a broken private equity deal. Like, you know, and when you hear that level of revulsion, you know, you got to believe that, you know, there's not a lot of optimists out there. So then you kind of fast forward a little bit and what's happening here is the problems. Yes, the profits are lower than worse thought, but the management team is fixing things. They're improving things here, improving things there. The streaming business, or at least I think of it as the distribution channel, which was money losing, is now money making, it's growing profitably. So things are better, but the revulsion is still there. I mean, I remember I talked to my former coworkers and they were like, Gary, you're insane. This is like sexually declining business. Why are you involved? You know, you don't need to be here. I talked to like a hedge fund specialist, you know, acquaintance of mine who does media. He's like, I won't touch this with a ten foot, you know, pole. You know, there's so many and I do distress all the time. This is just broken, it makes no sense. Yada yada yada. And the reality is that one of the first kind of mental model I talk about an article is that you have the good company, bad company combination, right? And like the example I give is just think of you have a good company that's a division and it's earning $2 a share in a bad company losing $1 a share combined company is making a dollar a share and the market is like, you know, let's put a multiple on that, let's say 15 times the whole thing traded 15 times. Even though, you know, you could shut down the money losing business and have $2 of earnings and you know, the stock would re rate fairly quickly. Now it has to happen, but you know, the Potential is there. Which leads me to the other mental model, which is, okay, you know, you have potential and kinetic energy, right? You have two balls, they're lying still, but one is on the floor, the other is on the edge of this desk. No, their current state is the same, but the future possibilities are different. You just need a nudge, right? And then the nudge and that activation energy, if you will, was the company decided to announce, hey, we are going to actually spin off the bad business, forgive the French, the shit go, as the market called it. Literally. There was actually, I think some major publication used that later. So hopefully I'm not two out of line and we're going to spin this company off and we're going to be left with the good assets. Warner Brothers library, HBO streaming and the cable networks. The business is declining. Going to trade separately, put a bunch of debt on it, hope it survives kind of thing. That confluence of events kind of made me think of Charlie Munger's point of Lollapalooza effect, which is his ideas with many multiple mental models come together. You have disproportionate effect, right? You have, you know, you don't have a 1.5x effect or 2x. It might have a 10x effect. You had a painted stock, you had a lot of, you know, intrinsic value potential. So the stock was trading 7, $8 a share. My intrinsic value estimate was, you know, in the low 20s on a standalone basis for the two pieces. And then you had this activation energy of a change coming that was going to unlock the value. So to me, that was a pretty good setup. And I, you know, I tried to be very rational with my position sizing and I'm a concentrate investor just by virtue of the fact that I want quality and I want a low price relative to value. And those two things are pretty rare in combination. So I thought this was a quality business, at least. Certainly the good company was. And then the price was like slightly more than a third of intrinsic value, which was. It's shocking for a large liquid company, right? This may be micro caps, you get that. And on top of that you had a event which. We'll talk about this in a second. Made it perfect for something I use very, very rarely. And I want to get this out of there because I don't want, if you're listening to this, I don't want you to come away thinking that Gary is sitting there like day trading options or zero day options or something like that. Couldn't be further from the truth. The vast, vast majority of what I do is long term holdings and good businesses at an attractive price. Occasionally though, a company can have long dated options that are even more mispriced than equity. And we can get into that if you want. And in this case that magnified the opportunity even further. So anyway, that was the setup and I think we can go in any direction you want from that.
- [19:16]
Bogomil
We'll come back to the different bits and pieces of the investment case, which I find fascinating and I hope the audience knows it's not a recommendation, it's a case study that we want to dive in and understand. But I really want to zoom in on the good business, bad business for a couple of reasons, I think. One, if you have a mix like that, the screens don't pick it up. I think the headline, what the business is about, miss it. So you really have to go deep and be very intimate, very familiar with the business to realize, wait, I'm buying two businesses. The market sees it at best as an average or maybe leans toward the worst part of the business and implies a much lower valuation. Tell me more about that. How did you know that? How did you see it? What made you think that it's two businesses? Can you talk more about that aspect of your research?
- [20:04]
Gary Mashuris
Yeah, I think, you know, I'm not one of the, I don't want to be one of these guys who, you know, is Captain Obvious and claims have amazing insight about something that's not that hard. So it wasn't hard to know that the businesses are pretty discreet. The company even broke them out separately. So it's not that I was Sherlock Holmes and found this Footnote in the 10K that said there was a separate business. I think the issue was one of perception, right? You had a scenario where the thing from this rapidly declining business, and again for context, cable networks, so Discovery Channel, tbs, tnt, cnn. What we're talking about is the bad business used to be an excellent business, right? It's still not a terrible business. What changed though is that the growth profile went from above average to declining. Right? So it's still a high return on capital, high margin business. It's just a declining business. And the market hates declining business. It doesn't know how to value them. It automatically assigns a low multiple to them, very low multiple. Because in truth, declining businesses are hard. Like they're hard for investors, but they're hard for management as well. Like if you think about managing a decline business that is darn hard. It's much easier to create a good culture, you know, like think of A growing retailer, they can assist manager at one store, promote them to be the manager of a new store. Everything is growing, everyone is happy. There are no layoffs, there's less politics, their pie is growing. So you don't have to have infighting and all that, that to like a shrinking business. It's much, much harder to manage. Right. So basically you have this taint where it's not that I market didn't know that, that they were two separate businesses, it just didn't care. And it just said listen, as long as I'm getting this bad CO in the mix, I don't want it because I have no idea what's going to re rate the stock. And all I'm seeing is, you know, high single digit revenue declines that's translating into double digit profit declines in this no business, which is the majority of profits right now but not the majority of value. And that's I think what the market got wrong. It was the majority of profits, but the majority of value. And if we fast forward to now, if you see from the bid the bid came in, the vast majority of value was in the good code. And I think that's what the market got wrong. It overly focused on the vivid negative and decline of the cable business and painted the whole picture with that negativity. If that makes so one of the.
- [22:40]
Matt Zigler
Parts of this then I'm just, I'm fascinated by the way you thought through this. Was the obvious part tangential to the good co is the ip. Like that's the part that any of us can look at and go of course, because we can all say I, I wish I made or was responsible or somehow tied to any one of all of these different pieces of intellectual property that they possessed in this wrapper, in this giant roll up that was going on. But the brutal part was we can all look at that and say I know that that's worth something. But the catalyst, like how did you understand the good assets, the good pieces of the ip? And then how do you even think about what the catalyst would be to eventually even unlock some recognition of the good co as you were just explaining it?
- [23:26]
Gary Mashuris
Yeah, I mean I think you're asking the right question. It's also very, there's two layers and like the second layer to your question is a very sophisticated one. So I'll come back to that in a second. But I think there's two layers of value to the Gutko or the Warner Brothers assets. One is simply what is there today and it's a profitable business. It's growing, it has a large moat around it. And one good test, like if you ever want to have a quick mental check of how good a business is, just ask yourself how much money and time would it take for someone else to replicate it or how much time and money would it take with someone else to make it a bad business. So this, you know, if Microsoft or whoever, whoever the deep populated company of the day is wanted to make Warner Brothers a bad business, it couldn't for a long, long time. You know, it would have to create similar IP from scratch, you know, lose a ton of money on big production films and so forth. And it would just not be able to, it wouldn't be able to do it, you know, so the mode is very clear, the profitability is very high. And I thought that those assets standalone were quite valuable. Now this more sophisticated kind of implication, your question is, well, there's an extra potential for those assets in different hands, right? So you have, you know, if you listen to what, for instance, Netflix, who's the current acquirer, we'll see how that shakes out. What they said on their call, they said, well, we love the assets, we don't want to change fire people, but we think we have ideas how to make them even more valuable in our hand. Maybe distribution, maybe additional creative activities, things like that. So as a platform, so I always like to think of a value stack. There is what's there now, demonstrable value, no. Then there's the growth of what's there. And then the third layer is what can be built on top of the current platform. Right. And it's that last layer of value that could potentially be higher in the hands of someone like Netflix than maybe in the current management. Right, but, but I want to make clear that it's not just a bet that sell will come in and create new value. The value already in there was well above the market price at the time. I think that's, you know, like Buffett, you know, makes this very clear, like you don't want to. If you need more than a four function calculator to figure out something is undervalued, it's not. You needed to hit it over your head, you know, kind of with a baseball bat and you need to basically, you know, when you, when something is incredibly undervalued, you should question, wait, the numbers must be wrong. There's no way it's priced at this level. As opposed to, gee, is it attractive? You ask them if it's attractive. We're true in other parts of life, but Won't get into that. Is it attractive? It's not attractive.
- [26:25]
Bogomil
Gary, I want to ask you about options and I'll make a dangerous topic.
- [26:30]
Gary Mashuris
Right, or a value investor for the audience.
- [26:35]
Bogomil
You know, really look at what you're buying when you start to play that game. I personally have not bought options in 20 years. I own a few at some point of my career. A topic for a different episode. Probably a couple of lessons there. Anyways, I find it easier, easier, more doable to find a business that's undervalued than to tell you, me, myself, my clients, when the price value gap will close. I honestly don't know. And I mean, only last week or two I was selling some, trimming some positions that I've held for 12 years. So sometimes it takes a while, but when they do, well, they can really surprise you on the upside. But I have no idea over the timing. So you used options, in this case, massive mispricing. You talk about how pricing models usually work and this was a hugely discounted stock in your mind, no pending catalyst, and you took a long term view, but with an expiration date. And you and I, I think many value investors don't like on an idea. Talk to me about it.
- [27:39]
Gary Mashuris
Yeah, so again, you know, I think that if you never touch options in your life, you'll do just fine. Like, you know, so I, I want to get that out there. And also again, I know we're talking about it kind of in this case, but it's not all representative of the majority of my investment. Which brings me to another point. So when I teach my seminar, we start with security analysis. And I think Eric Ben Graham in there defined investing in a very specific way. And I remember because I've done that, I've read the book four times and I teach it every year. So he said an investment operation is one which upon thorough analysis, promises both safety of principle and a satisfactory return. And again, not to dive in too deep, but the words are intentional. They're in a separate block paragraph. This was in the early 1930s, right after the 1929 crash. So he was very deliberate in defining things. It was not the choice of words was carefully chosen. He said an investment operation did not say an investment. And what that means to me is that you really want to think about margin of safety at both the individual investment level and the portfolio level. But ultimately it's at the portfolio level that margin of safety is the most meaningful at the level of operation over time. Operation. He was referring to a partnership like he was running like one, like I'm running. And basically the idea is that you don't have to have every single investment have no more than 5% down say or something like that. But the portfolio as a whole would be quite safe. So let me unpack that and to get into know options. So first of all, right, you know one mental model I have for portfolio construction and you know, and I'm not trying to gamify it so I don't want, I don't want to take a serious thing and make into a game. But think compare portfolio to as we Americans call the soccer team or the rest of the world calls a football team, right? You don't want to have you know, 11 goalies or you don't want to have 11 strikers, at least not if you want to win at the competitive level. You're going to have some forwards, you're going to have some midfielders, you're going to have some defenders and you have a goalie in some proportion, right? So I think a good portfolio also has elements where the vast majority of the team is not strikers. They're you know, somewhere further back in the game. Otherwise you know, if the strikers don't score then you know, you get a lot of goals scored in you. So most of my portfolio is composed of good safe businesses with high individual margin of safety. That in turn I think allows me to occasionally have small portions of the portfolio where the expected value is extremely attractive. But, but there is a risk of total loss. In this case we're talking about the most disposition ever was at cost was 5% which by the way is huge for an option position. I've only done this once in my almost a decade. And again the reason was the confluence of mental models and again not to get into the satirics of options, but the options themselves are mispriced on top of the mispricing of the equity. And here's why. And the reason is the market prices options using something called as you know, the Black Scholes formula, right? And that basically assumes that stocks wiggle randomly around the mean and that mean moves forward at the risk free rate. That is pretty useful for like a one or two, three month option. As you get into longer options there's a mispricing because the longer term options, the intrinsic value of the business shouldn't be growing at 3, 4%, it should be growing at 10% plus or whatever your discount rate you're using for the market. So the longer the, the long the option, the bigger the mispricing. Now if you Add that to the fact that here you had an event. So what's the big negative of option? The big negative is expiration date, right? It sucks. Technical term. It sucks because you always, as an investor would prefer to have time on your side. You want to be able to be wrong for a bit and for the business to solve its difficulties and not have the clock hold on you here you will have the clock holding you. That is a huge, huge negative. And which is why I say vast majority of the time you should not use up. However, you had an event and that event was the company announced that they're going to, in the first half of 2026, they are going to spin off the bad company. Is that a guarantee that the stock will rerate? It's not. But does it significantly increase the probability now that the major reason for the mispricing will be removed? Meaning that the pain of the declining business affecting the valuation of the good businesses? In my estimation, the probability of rerating was much, much higher. And so the options I took were like 18 to 24 months for the most part, which I felt gave me plenty of time horizon for this event. Importantly, I was buying them at what I thought was about 10 cents on the dollar of intrinsic value. Intrinsic value being defined in this case, not in the language of option, but saying if my intrinsic value for the business is roughly right and I take the pay out of the option and discount to the present, that's kind of the value, the fundamental fuel value of the option. So I think you had this extreme mispricing plus an event which aligned to a large degree the time horizon adoption with the time horizon of the likely correction of the mispricing. So I would not recommend doing this on a general stock because in general you have no idea. Even if you see a big price to value gap, if that will change next month or in three years. But here you had this extra factor which made it much more likely. And that's why I thought it was a very high expected value investment. Even though the downside of that 5% was still 100%, it was possible that would expire work.
- [34:02]
Matt Zigler
There's another angle inside of this that I think you wrote about very eloquently and I think it's really interesting. And it's in the inflection point, basically when the, when the auction happens because you shift from here's what it's intrinsically worth the intrinsic value to what's the most somebody's going to pay for this thing, right? And ego comes splashing around. I'M very curious about how you both thought through that in real time and how you look back on that part now.
- [34:29]
Gary Mashuris
Yeah. And by the way, that's anathema to value investors, right? You know, like we hate, we hate the idea that, you know, it's like monotheism, right? You know, like there's like you have to have only intrinsic value matters. Yes, there'll be noise in the short term, but in the long time, in the long term price will approach intrinsic value. That is the foundational belief of almost every value investor I know. No matter whether they buy compounders or they buy distressed cheap stocks, they, they believe that and obviously there's changes in the value and there's a lot more involved, right. And then if you start to introduce other mental models, like I bristle at that, like this is the first one I ever heard of was George Soros's theory of reflexivity. And just as a quick detour goes, something like this. Most of the time price follows value, but other times value follows price. For example, like 2008, 2009, bear Stearns, right? There were, you know, fears about Bear Sterns in the market. The stock price went lower. The pro that created additional fears among the customers. The customers left or some more customers left, the price went even lower, more customers got scared and eventually Bear Sterns went on there was bought by JP Morgan, right? So in this case it was a reflexive spiral where the price was changing the value, right? Not the value, changing the price. Now there, there are other models, in this case the auction mental model. And you know, again, not to geek out on you completely, but you know, I'm sure you probably know the idea of Nash equilibrium, right? You know, game theory, you know, John Nash created this idea that, you know, you have a payoff matrix and there is. The game has a stable equilibrium. Some games have an equilibrium where this outcome happens and there's no reason to deviate. And that's the idea of intrinsic value. It's like it's meant to be a Nash equilibrium. Like you deviate temporarily but eventually you approach it and you stay at intrinsic value because it's the correct number. And if you go too low, too high, different actions happen to correct that. Here you have an unstable equilibrium. And, and I think the story I told. How so I went to this behavioral finance seminar at Harvard 20 odd years ago and Professor Max Baserman did this experiment where he sold a $20 bill to a room full of senior investment professionals. I was by far the most junior for like 24 bucks. And I came up to him after the seminar. I said, listen, does this always work or are we just a particularly stupid bunch of people as you encounter today? And he said, no, no, I've done this hundreds of times. It always works. And then I was a speaker at an investment conference a couple of years ago and inflation, 20 years have passed. So I decided to do a hundred dollar bill and I sold this $100 bill for $120. And I only stopped at $120 to not embarrass the person too much. And the point is, is it possible to have a set of circumstances where you locked into a payoff matrix matrix that looks like this, Pay a little bit more and your payoff is positive or stop bidding and your payoff is negative. And that's what causes the spiral. That's why people keep going. I won't get into the detail the mechanics of the auction, but in this auction, right, once you have two serious bidders, it's not just about money to them. I mean, these are like alpha billionaires, you know, and I'm not a billionaire, you know, I don't know about you guys, but like I imagine so I can only speak from like imagination.
- [38:21]
Matt Zigler
Bogomil's leaps position hasn't paid off yet.
- [38:23]
Bogomil
So it's those legacy.
- [38:26]
Gary Mashuris
You're a future future billionaire. On paper, I think all three of us are. But anyways. But you know, you have, you know, so much public reputation, ego invested that it's no longer about what is the intrinsic value. Paramount, Skydance and the Ellison family on one hand, and Netflix to lesser, but not sitting there saying, gee, let me take out my Excel spreadsheet, punch in the DCF and say, exactly what's the intrinsic value of this beast? Which by the way, the intrinsic value is always a range, right? We don't know exactly what the intrinsic value is. They're saying it's shiny. I already decide I want it and I'm going to get it. You know, kind of again, I'm being facetious with my language, but like that's the level and there are all kinds of tactics. You obviously don't want to overpay more than you have to. Maybe you threaten to walk away. You know, there's a game, but it's very likely that things have tripped it. Now does that mean you go and just say, hey, time to gamble. I have this clever mental model, you know, intrinsic value out the window. I'm just going to gamble that these guys will keep outbidding each other. I think that's Very dangerous again, and that is extremely speculative. But options for all the negatives, which are huge, again, I'll keep emphasizing options for the most time, suck for long term investors at least buying options, call options, but they have the ability to keep restructuring risk. And so in my case, what I did when we entered this auction stage is I took most, the vast majority of, of the profits off and then I locked them in because. And in the outcome that's played out, that hurt me. But I always teach my students, like, look, you know, just because something didn't have the maximum payoff doesn't mean it was the word, a bad decision. You have to consider many possible outcomes. And the auction could have aborted. There could have been the regulatory interference, there could have been, you know, a market crash. And Oracle stock, which is a source of wealth with Ellison family on the paramount side, could have cratered and who knows, right? So the way I structured it was I took the vast majority of the investment and locked it in and then I left the tail position, but with a lot of what's called convexity. Convexity means in the short term it doesn't go up much in response to price. But if price reaches a certain point, there's a hockey stick effect. Right. And the theory behind leaving that little, last little bit was the auction model that, hey, it's not, it's, you know, people were talking about whether the bid will be 20, 19 or 23. I said, wait a second, there's a pretty good chance this could be 30 plus because you can easily get there in the numbers. My standalone intrinsic value was low 20s. If you apply a typical control premium for large companies of say around 40%, there's your $30 right there. And that doesn't even get into any kind of irrational or seemingly irrational bidding. The long story short is you don't want to gamble on things that are unforecastable, which is how far the auction will go. And certainly if you. But I think that you can change your risk profile where you're taking the vast majority of the risk and taking it off and you're leaving a very high expected value, small amount. We were talking about a couple of percent at that point, but then again at a very convex payoff. Anyway, I told you much more minutiae than you probably wanted to hear, but that's kind of how I thought about it live at the time.
- [42:10]
Bogomil
We did want to hear all about it and I hope this audience is paying attention because I think it's pure gold what you just shared when it comes to investment philosophy, especially the last bit, taking money off the table, especially when it feels like a gamble at that point, but leaving a small position so you still participate. I've seen so many times when a long term position that I trim, trim, trim, it doubled again. It doubled again and doubled again and far exceeded anything I expected of it when I initially bought it. So I think there are two parts to it. There is time to take money off the table. Don't take all of it. Leave some, obviously case by case. But there are opportunities that can be much bigger, much better than.
- [42:52]
Gary Mashuris
Yeah, yeah, no, I think you made a very wise point, is that you have different classes of investment and some classes of investment have a long right tail. And that could just be a compounder or a business where management keeps an out executing expectations or keeps adding value in some new ways. Or it could just be something like this, right? Where there's just a long right tail of possibilities. And then you have very cap. Finite businesses. All right, It's a cyclical, I think it earns a dollar in mid cycle. The stock is trading at $5 because people don't believe it or they want to see the turn in the cycle before they invest. The stock reaches whatever fair multiple you think it Is, whether it's 12 or 15, whatever it is, there is really not much rational right tail. Now maybe it'll get overvalued because people overestimate the cycle. Fine. But there's no real reason for the right tail to exist. So I think what you're talking about and what we're talking about is very much applicable to businesses or investments with that long right tail. And I think the general point of this, if you're listening to this, I would say is so important is that it's not enough to have the right mental model. You have to apply it. You have to understand what circumstances does it apply under.
- [44:14]
Bogomil
So speaking of mental models, when I was reading your essays on Warner, which by the way, I highly recommend for this audience to after listening to this, go and read it in your own words, how you framed it. I saw two things that really hit me. One, this eternal need for us humans to be entertained. On the other hand, an industry that has been entertaining us going for a massive transformation. A lot of it is around delivery, right? It's not a dvd. It's not as much the movie theater anymore. So the channel is changing, but also the production is changing. The distribution, the global distribution. The fact that you can have the same show movie available to people in a hundred Countries overnight, which is unheard of. We're kind of accepting it, but really unheard of a decade or two ago. Right. The logistics. Talk to me about this eternal need to be entertained and this massive transformation in this industry. Like, how do we. It's like no change at all and a massive change at the same time.
- [45:13]
Gary Mashuris
Yeah, I mean, it's a fascinating space because if you think about quality of business, right, One of the questions is how permanent is demand? And you can say, okay, girls, I know teenage fashion, apparel, you know, the man can change when the women what was in fashion, you know, one year will be completely out of fashion the next. And you have a bunch of inventory that nobody ever wants, you know, buy at any price on the other side that you have things that always will be in demand. Right. The basic food, you know, but. And this in a sense is foods for the mind or the soul, whatever you want to make. So we always want to be entertained. And the inventory, in this case movies and libraries of content and characters, intellectual property, never go stale. They might get under monetized or under created at some point. But, you know, if you have Captain America or whoever, you know, you can always build, you know, on top of that or Harry Potter or even they're making a new Lord of the Rings, which again, sometimes I feel like, you know, like Godfather, you know, three is probably planning. You don't want Godfather four or something like that. But the point is you have evergreen demand and you have evergreen inventory. Now you do have new distribution method. And I think where the. The challenge is, is, you know, and this is a longer conversation than probably we have time for, is you have ports which essentially hijacked the bundle, right? And you have this bundle in America, at least in the US less so in New York and other places, which is very expensive because you have to subsidize the, whatever, 10, 20% of the audience that watches sports. And you're not allowed contractually to have a truly skinny bundle of just what people want to watch who don't care about sports, which is most people don't watch sports, or at least they wouldn't pay the money monthly to watch sports that would be required to support it. So you have this very big bundle which accelerates this port cutting or substitution away to various streaming services. And this is classic if you read Clayton Christensen, Innovators Dilemma, Innovator's Solution. Netflix is right there, which the irony, I'm sure you know it. I don't know how probably many of you do, but for those of you who don't? Jeff Bukus, who is the former CEO of Warner Brothers, once called Netflix the Albanian army. And it was in the context of saying, hey, look, they're not really a threat. It's like the Albanian army is going to take over the world. And I think Reed Hastings, the CEO of Netflix, actually used that internally to motivate the troops and say, hey, you know, he showed up, I think, with like Albanian army berets or something like that to his senior management team or something. The point is, this is like, this has occurred many, many times, like in steel, where you have rebars, the low end of the market, nobody cares. The big players let them come in and then they move up and up and up. And Netflix came in just like that. It's an amazing case study. Amazing management team. They came in and said, we're just going to give you, the movie studios extra revenue because we are going to send these red, these discs in the red envelope. Then we're going to give you extra revenue for free. You can monetize extra by just making a stream for like $8 a month, $9 a month. No big deal. It's not going to cannibalize your revenue. And then little by little, they get bigger, they get bigger, they get bigger. Then they started doing originals. Then they started doing originals better than the incumbent players in many cases. And, and the short sightedness of the industry allowed Netflix to get to a level where they're so powerful that they're impossible to unsee. There are other issues, like John Malone likes to point out. There's this regulatory unfairness where Netflix gets to be right on the infrastructure of the cable companies and so forth. But regardless, you have this digital distribution and you have this plethora of content now being created across the globe locally as well as, you know, centrally. And I think the winners are the consumers. I think the losers in many cases are the legacy businesses that didn't adjust in time, unfortunately.
- [49:43]
Matt Zigler
Well, speaking about adjustments, one thing that I really wanted to get into with you because, and I feel like Bogumil will share the same arc on this, is you went from not really using AI at all in your processes right to what, middle of 2025 being like, oh, yeah, yeah, I'm playing around a little bit. And then I think by November I was seeing you write about the thousands of hours or some ridiculous quantity and Hundreds.
- [50:10]
Bogomil
Hundreds.
- [50:10]
Gary Mashuris
I don't, I don't, I don't want to oversell. Hundreds. Yeah, but yes, okay, okay.
- [50:13]
Matt Zigler
I had a leap option out on that.
- [50:15]
Gary Mashuris
1. So, yeah, you know, if you lever it up, if you lever it up.
- [50:20]
Matt Zigler
With thousands, I, I'm really curious about what happened and then what. The process is taking shape now, coming into 2026 here for you. What's the fascination with AI in the process?
- [50:32]
Gary Mashuris
Yeah, well, so first of all, I have no special advantage in AI. I have a computer science degree from MIT from 25 years ago. But that gives me, other than being able to think logically, it doesn't give me any special insight in anything. And like, if you're listening to this, I would encourage you on AI. The major takeaway for you is go and start iterating on how you're going to incorporate into your process. Don't wait for some final state or some perfect solution. Start using it systematically. And that's what I started because I said, well, this, this is a tool. It has potential I don't fully understand, but it's positive. I don't think it's some kind of magic genie in the bottle where you say AI, which stocks will go up next month and I'll give you the stocks. I mean, giving a ridiculous extreme example. But I think that if you take the hype away, and there is a lot of hype because there are a lot of people trying to charge you for this, charge you for this, create businesses on top of ChatGPT or Claude or Gemini, whatever, and basically put a wrapper on it and say, here's, you know, pay us a lot of money. I decided to say there might be value in some of those businesses for sure. But let me just go from first principles to tools. Think I'm a very much of a process guy, right. I pride myself on being systematic, process driven how I approach investing, which lends itself then to adding AI in because I'm not sitting there in an armchair saying, oh, what's going to be the next hundred bagger? You know, oh, okay, I got, it's this guy. I have a idea generation process, I have an analysis process, I have a portfolio construction process, I have a risk management process and so forth. So I start using AI experimenting, I start experimenting with different prompts, with different LLMs. So comparing how, you know, my interns were helping me with that as well. And so what the result, the result of all of this has been is I wrote this kind of white paper, it's really available. I encourage you to take a look called the AI Equity Analyst that I put up online. And it shows where I think right now, based on where we are at today, you can incorporate AI into your process. And the idea is a symbiosis, right? There are going to be steps that you can purely use AI for or at least substeps, or like, say, idea generation might be an example where they're, you know, instead of, you know, you can have AI spit out pretty darn good list of special situations if you're looking at that, which would take you hundreds of hours, maybe at least dozens of hours to find on your own. So great use case very quick. You don't mind the occasional errors and so forth. We can get into why two places in the process where you want to combine your efforts with AI together. And finally two places where I think, at least, right, you don't want to outsource. So I think you don't want to be using AI to be lazy or take shortcuts. I think you want to use AI to save time on less differentiated tasks, to then invest that time back into where you can add more value, more qualitative judgment, more kind of primary research, perhaps, whatever your process is. So I think we are at this really unique and exciting stage where no one really has a huge advantage over anyone. And the only way I think to lose is if you don't engage with it. And you either assume it's all hype or you assume that it's not for you. I've had grizzled value investing veterans reach out to me, give me good feedback on that paper, which, by the way, was the selfish reason for writing is that, hey, you know, I want people to write. You know, I have exact prompts, I use my process all in there. And people are reaching out to me, saying, oh, this is me. What about this? Or, hey, this might not work. You know, like, it's almost a collaborative kind of a public collaboration kind of aspect to it, as there's nothing gated. Everything is, you know, in the public arena. But I think if you don't use it, you missing out on that learning curve of how you. Because your process should be different from my process. It's because you're different than I am. You need to figure out how to use it yourself. And the only way to do it is to get, like, roll up your sleeves and start actively applying.
- [55:01]
Bogomil
So I'll mention for the benefit of this audience, Gary and I recorded a Talking Billions episode all about AI. It will air in January. Incredible conversation, an hour and a bit. But I want to ask you one little teaser from the conversation we had. So people look at AI as time savings. You make a point beyond that and you say that certain analysis can be actually superior than human analysis. You asked the question what wasn't explicitly said but was implied, for example. So you're kind of looking for the what's missing. Can you talk about it briefly how that's that work? Because it's something that I think people are not thinking about as much the category two as you call it.
- [55:38]
Gary Mashuris
Yeah. So like I talk about category one, which is doing what humans can do, but just faster or cheaper, versus category two, which is doing something we couldn't do even though we had more time or money. So like the one case I found, and I wish I had another 10 to fair, but those are hard, is for an example, let's say you have access to a library of expert interviews, Tigus, whatever, glg, whatever you use, right. And let's say, you know, you can put it in with something called NotebookLM, which is Google's tool that uses their Gemini model, and you can have an interaction with that purely based on that knowledge of those expert interviews. And then you can ask it to find patterns that I think even if you read every single transcript you or I as a human would probably not find. An example would be what was left unsaid. Like, what are the things that were implied by these experts about the management team or about the culture? And like, the example I would give is when I was at Fidelity, they brought in former CIA interrogators to teach us how to conduct management interviews. And one of the things that stuck with me from that is that we were told, I think, correctly. People don't lie by telling you the opposite of the truth. They don't know if you ask them how old you are, they don't tell you, you know, 57 when they're 46. I think they answer a different question truthfully. So the example I think in our conversation that you referred to was maybe you ask, hey, how good was the company's culture? Something like that. And maybe the person, the former employee you're talking to answers, I really enjoy going out for beers with the guys after work. And you might leave that conversation thinking, answer the question. Yeah, that was a positive answer. It was, but it was a positive answer to a different question. I found that AI in a few cases that is really good for picking up those kind of things and also finding common threads. And like, for instance, like I have a standard list in that AI equity analyst. I have those, these prompts and one of them for this and that. Like, what I ask is, what are common areas of agreement and disagreement among the experts. But AI is so good at looking at text and parsing in the way that, ah, they all agree that the CEO is a narcissist, but they love the fact that he has great, you know, vision or whatever. I don't know, you know. Yeah, I'm just making this up. But the point is you might miss that as you're going through the details of each expert interview. Yeah, that stuff, I think, could be gold because it's so quick and it's just great.
- [58:33]
Matt Zigler
I think it's fascinating. I love that you're sharing this work in public with the white paper, and I love seeing the conversations back and forth as people tweak this, because your prompts from six months ago will not be your prompts today. The models change, the LLMs change, the way you ask the questions, the way you understand the answers. It all evolves. And it's a really cool process that you have to feel this way, like, get in the stream with the progress to let it carry you forward.
- [59:00]
Gary Mashuris
Yes, yes. And I think, I mean, look, you know, I may. It may have been like a final point in this. You know, I remember back when I kind of made my process public when I launched Silver, and I, you know, said, you know, anyone who wants to, here's my owner's manual where I'm very in depth about how I invest. And my mother who always, you know, I'm the only child, she always looks out for me no matter how old I get. She's like, oh, why are you giving away all your secrets? And blah, blah, blah, blah, blah, blah. I'm like, these are not secrets. I mean, Buffett gives away all his secrets. How many Buffets are there people with Buffett, like, returns? I mean, not to get into this tangent, but there are plenty of people claiming to try to clone Buffett. No one has succeeded so far. As far as I know, the trick is in implementation. So I think that there's far less risk in seemingly being generous than trying to sit in this isolation in this ivory tower and try to come up with some proprietary way, then collaborating, putting your work out there, and try to iterate faster and try to get to the right answers for you, or at least better answers for you in the meantime, helping other people get to the right answers for them. So I think that the differentiation in terms of investing results over time will come from other things. Not from the tools, but from temperament, your investment structure, a whole bunch of other things. It's not going to be because I have a clever LLM prompt than you do.
- [60:28]
Matt Zigler
One of our favorite closing questions. If there's one thing you could teach the average investor, what would you like to teach them?
- [60:35]
Gary Mashuris
Yeah, no, I think about this a lot because of coming back full circle. We came into this country, we were poor. My mom had to be on welfare for her first couple of months till she found her full time job. So I think about the average investor a lot because as soon as she found that job, she, you know, started putting money into mutual funds for very few dollars of savings every month. And that's how I got interested in investing because I'm like, what are these mutual fund things? But I mean, I would say badly this might not be exciting is that the incentives in the industry on average are not in the favor of the customer. So if you're an average person, you, you know, have a couple hundred thousand dollars of savings, I would, you know, strongly caution you against trying to buy things that are being sold to you. Whatever the flavor is, whether it's private credit or you know, private equity for retail, whatever that's being sold to you. And look for the incentives of the people selling to you, like how are they compensated, how are they motivated and if you're unsure and this is not financial advice, but my personal opinion would tell friends is there's nothing wrong with going to Vanguard and just staying in a broad low cost index fund because if you can't understand something yourself, chances are someone else who is selling it to you, they're selling it to make money off of your portion.
- [62:05]
Matt Zigler
A very silver ring lesson to come back and ever I did hear on Gary, if people want to find out more, they want to read the substack, they want to see the paper. Where should they look you up on the Internet?
- [62:16]
Gary Mashuris
Yeah, absolutely. So the behavioral value investor substack, you know, is a great place. I'm on LinkedIn, you know, happy to connect there. I'm pretty active. And then the paper, you know, it's too big to post but it's, there's a link and I'm happy to and give it to you guys so you can include it or communicate through other ways. If you just reach out to me and you can just automatically download the AI Equity analyst white paper on AI, take a look for yourself.
- [62:44]
Matt Zigler
Fantastic. We're going to encourage everybody to do that. Bogomil, thanks for co hosting with me. I'm Matt Zigler, that's Gary Mashuris. Gary, thanks again so much for coming on Excess Returns. You're going to have to come back.
- [62:55]
Gary Mashuris
Thank you so much. Really appreciate your time guys, and you. Thank you for tuning in to this episode. If you found this discussion interesting and valuable, please subscribe on your favorite audio platform or on YouTube. You can also follow all the podcasts in the Excess Returns network@excessreturnspod.com if you have any feedback or questions, you can contact us@xsreturnspodmail.com no information on this podcast.
- [63:18]
Matt Zigler
Should be construed as investment advice. Securities discussed in the podcast may be holdings of the firms of the hosts or their clients.