kase fund ltr to investors-12-13

8/13/2019 Kase Fund Ltr to Investors-12-13

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Whitney R. Tilson phone: 212 277 5606

Managing Partner [email protected]

Carnegie Hall Tower, 152 West 57th Street, 46th Floor, New York, NY 10019

January 1, 2014

Dear Partner,

I hope youve had a wonderful holiday season and wish you a happy new year.

I will send you my annual letter later this month, but wanted to give you a quick updateimmediately, as I do at the beginning of every month.

Our fund rose an estimated 3.9% in December vs. 2.5% for the S&P 500 and 1.3% for the HFRXEquity Hedge Index. For the year, our fund finished up 16.8% vs. 32.4% for the S&P 500 and11.2% for the HFRX Equity Hedge Index.

Winners on the long side in December were Grupo Prisa (B shares) (+23.5%), Hertz and Avis(18.0% and 9.7%, respectively) and Spark Networks (9.2%). Thank goodness I exited dELiA*sin November, as it tumbled 26.7% in December.

For all of 2013, our three largest positions all year, Howard Hughes, AIG and Berkshire, allperformed well, rising 64.5%, 44.6% and 32.7%, respectively. Other winners included Netflix(297.6%), Grupo Prisa (B shares) (172.6%), Deckers (109.7%), the Japan side fund (90.5%through November), Canadian Pacific (48.9%), Goldman Sachs (39.0%), and Citigroup (31.7%).The only decliners of note during the year were Spark Networks (-20.9%) and Iridium (-7.0%).

It was a different story on the short side, however. As Ive discussed in previous letters, 2013was horrific for pretty much all short sellers and we were no exception. I will discuss the yearslowlights and lessons learned in my annual letter.

Our short book was flat in December, despite the markets strong upward move, thanks primarilyto InterOil (-41.8%), Krispy Kreme (-24.0%) and Opko Health (-19.9%).

InterOilIn last months monthly update, I wrote the following about InterOil:

InterOil, however, jumped 27.3% because the new CEO promised that the company would sign a

deal by the end of the year with an energy major (presumably ExxonMobil) to monetize thenatural gas discovery InterOil claims to have made in Papua New Guinea. I expect that InterOilwill, in fact, sign a deal (despite years of broken promises), but believe that it wont be anythingclose to the jackpot bulls are expecting. Rather, I expect nothing more than an indication fromExxonMobil that it would be interested in buying any natural gas InterOil produces many yearsfrom now. If Im right, theres a lot of downside for the stock based on the companys absurd$4.3 billion market cap today.


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In addition, heres a transcript of what I said about InterOil during the Q&A session followingmy presentation on Lumber Liquidators at the Robin Hood Investors Conference on Nov. 22nd:

Moderator:Whitney, since you were nice enough to come with a short, would you mind if Iasked you about another short, which you are public on and have written a lot about that I think isclose to its all-time high? Its a Papua New Guinea oil and gas exploration company which has abig market cap and basically no earnings and virtually no revenues to support it.

Me:Sure, its called InterOil IOC is the ticker. Lumber Liquidators is one of my newest shorts;I think InterOil may be the oldest short in my book. Its fluctuated between $50 and $100 for fiveplus years and is in the high $80s right now. It has a $4.3 billion market cap for a company thatsdone nothing but burn money for 15 years going around drilling wells in one of the worlds mostcorrupt and primitive countries. But now they are on the verge of a deal. On the conference calllast week, the new CEO said We are going to sign an asset monetization deal. Theyve beenpromising one pretty much every quarter for the last five years and its all come to naught, butnow theyre serious. By the end of this year, theyre going to sign a huge asset monetization dealand the stock has run up a lot on that news.

ExxonMobil is building a big LNG plant right nearby and if InterOil actually does have anynatural gas, the logical thing to do would be to sell it to Exxon. Exxon knows that and I thinkExxon is perfectly happy to sign an offtake agreementand thats all it will be.

I think this is a buy-on-the-rumor, sell-on-the-news kind of story.

Moderator:Its one of these odd ones where youre kind of hoping for a deal so theressomething to analyze. If theres no deal, which sounds likelybased on what you said of thehistory, then by the beginning of next year, itll be the deal thats coming by the end of 2014.

Me:Exactly. Investors seem to have an infinite capacity to believe a company that hasconsistently let them down, so if they actually sign a deal, people will see

Theyve never run an extended flow test, which is what makes me skeptical about the size of theresource.

So I think there will be a deal thats very back-end loaded and could cut the stock in half.

Two weeks later, InterOil announced a deal with French energy giant Total and, as I expected, itwas a disappointment and the stock sold off sharply. I shared my analysis in an article Ipublished on Seeking Alpha, Why Theres More Downside for InterOil(see Appendix A). Heresthe beginning:

After InterOil announced its long-awaited asset monetization deal with energy supermajor Totalon Thursday night, the stock plunged 37% on Friday (before popping 10% today) because thedeal failed to meet investors overheated expectations. So is it time to declare victory on whatwas my largest short position and move on? No. Though I took some profits today, I maintain ashort position because I think theres more downside to come for InterOil.


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Rather than engaging in breathless speculation about InterOils future (fueled by the mostclueless, conflicted analysts and venomous, anonymous message board trolls Ive encounteredin my career), its now possible at last!to analyze this company based on real information.

There are some interesting parallels with K12. When I presented K12 at the Value InvestingCongress on Sept. 17th, it had risen 71% YTD and become a nerve-wracking 3.4% short positionin our fundbut I stubbornly refused to cover any of it. Three weeks and one day later, the stockblew up, falling 38% in a day.

Similarly, when I mentioned IOC at the Robin Hood Investors Conference, it had risen 56%YTD and become a nerve-wracking 3.4% short position in our fundbut I stubbornly refused tocover any of it. Two weeks and one day later, the stock blew up, falling 37% in a day.

Lumber Liquidators

I published another article in December in Seeking Alpha entitledMy Analysis of LumberLiquidators Updated Guidance(see Appendix B). Heres an excerpt:

After the close yesterday, Lumber Liquidators updated its guidance (see press releasehere)andreleased a new investor presentation (here). I believe this new information provides evidence tosupport the key pillar of my investment thesis (outlined in my original presentation, postedhere):that margins will come under pressure, leading Lumber Liquidators to miss the exuberantexpectations built into the stock price.

Most importantly, LL guided to materially lower gross and operating margins relative to Q3and the trend over the past 2+ years, as this chart shows:

I have covered most of my InterOil and Lumber Liquidators short positions, and hope to haveanother opportunity to ramp them up once again.
http://finance.yahoo.com/news/lumber-liquidators-updates-outlook-conjunction-220500832.htmlhttp://finance.yahoo.com/news/lumber-liquidators-updates-outlook-conjunction-220500832.htmlhttp://finance.yahoo.com/news/lumber-liquidators-updates-outlook-conjunction-220500832.htmlhttp://investors.lumberliquidators.com/index.php?s=19&item=11http://investors.lumberliquidators.com/index.php?s=19&item=11http://investors.lumberliquidators.com/index.php?s=19&item=11http://www.tilsonfunds.com/LL.pdfhttp://www.tilsonfunds.com/LL.pdfhttp://www.tilsonfunds.com/LL.pdfhttp://www.tilsonfunds.com/LL.pdfhttp://investors.lumberliquidators.com/index.php?s=19&item=11http://finance.yahoo.com/news/lumber-liquidators-updates-outlook-conjunction-220500832.html


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ConclusionEntering 2014, I believe our fund is well positioned to outperform, as I will discuss further in myannual letter.

As always, thank you for your support and please let me know if you have any questions.

Sincerely yours,

Whitney Tilson

The estimated, unaudited return for the Kase Fund versus major benchmarks (includingreinvested dividends) is:

December Q4 YTD Since Inception

Kase Fundnet 3.9% 9.9% 16.8% 146.0%

S&P 500 2.5% 10.5% 32.4% 79.4%HFRX Equity Hedge FundIndex

1.3% 4.2% 11.2% n/a

The Kase Funds returns reflect an estimate for the Japan side fund because I dont get the performance report for this fund untilapproximately a week into each month. Any necessary adjustments will be made in the performance table of my annual letter.Past performance is not indicative of future results. Please refer to the disclosure section at the end of this letter. The Kase Fundwas launched on 1/1/99.

Kase Fund Performance (Net) Since Inception

Past performance is not indicative of future results.

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Jan-99 Jan-00 Jan-01 Jan-02 Jan-03 Jan-04 Jan-05 Jan-06 Jan-07 Jan-08 Jan-09 Jan-10 Jan-11 Jan-12 Jan-13 Jan-14

(%)

Kase Fund S&P 500


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Kase Fund Monthly Performance (Net) Since Inception

Past performance is not indicative of future results.Note: Returns in 2001, 2003, 2009 and 2013 reflect the benefit of the high-water mark, assuming an investor at inception.

Kase S&P Kase S&P Kase S&P Kase S&P Kase S&P Kase S&P Kase S&P Kase S&P Kase S&P Kase S&P Kase S&P Kase S&P Kase S&P Kase S&P Kase S&P

Fund 500 Fund 500 Fund 500 Fund 500 Fund 500 Fund 500 Fund 500 Fund 500 Fund 500 Fund 500 Fund 500 Fund 500 Fund 500 Fund 500 Fund 500

J an ua ry 7 .8 4.1 -6.3 -5.0 4.4 3.6 -1.8 -1.5 -5.5 -2.6 4.7 1.8 1.1 -2.4 1.9 2.7 2.4 1.7 1.9 -5.9 -3.6 -8.4 -1.6 -3.6 -2.8 2.4 12.6 4.5 4.5 5.2

February -2.9 -3.1 6.2 -1.9 -0.6 -9.2 -1.1 -2.0 2.9 -1.6 7.0 1.5 2.1 2.0 -3.1 0.2 -3.3 -2.1 -6.9 -3.3 -8.9 -10.8 7.3 3.1 4.1 3.4 -0.8 4.3 0.8 1.4

March 4.1 4.0 10.3 9.8 -2.6 -6.4 3.0 3.7 1.4 0.9 3.9 -1.5 3.9 -1.7 3.9 1.3 -0.8 1.1 -2.3 -0.5 2.9 9.0 4.6 6.0 -4.1 0.0 10.9 3.3 1.3 3.8

April 2.1 3.7 -5.1 -3.0 5.1 7.8 -0.2 -6.0 10.5 8.2 2.4 -1.5 0.6 -1.9 2.2 1.4 4.4 4.6 -0.9 4.9 20.1 9.6 -2.1 1.6 1.9 3.0 1.3 -0.6 0.1 1.9

May -5.7 -2.5 -2.8 -2.0 1.8 0.6 0.0 -0.8 6.6 5.3 -1.4 1.4 -2.6 3.2 1.8 -2.9 2.5 3.3 7.9 1.2 8.1 5.5 -2.6 -8.0 -1.9 -1.1 -13.6 -6.0 2.8 2.3

June 2.2 5.8 4.1 2.4 4.6 -2.4 -7.3 -7.1 2.9 1.3 0.1 1.9 -3.1 0.1 -0.2 0.2 -3.0 -1.5 -1.2 -8.4 -5.0 0.2 4.5 -5.2 -2.4 -1.7 0.5 4.1 -1.0 -1.3

July -0.7 -3.2 -3.6 -1.6 -1.1 -1.0 -5.0 -7.9 2.3 1.7 4.6 -3.4 0.5 3.7 -0.9 0.7 -5.4 -3.0 -2.5 -0.9 6.8 7.6 3.5 7.0 -4.6 -2.0 0.2 1.4 -0.1 5.1

August 4. 1 -0.4 5.4 6.1 2.5 -6.3 -4.3 0.5 0.4 1.9 -0.9 0.4 -3.2 -1.0 2.9 2.3 1.7 1.5 -3.3 1.3 6.3 3.6 -1.5 -4.5 -13.9 -5.4 -7.2 2.3 -5.8 -2.9

September -3.3 -2.7 -7.2 -5.3 -6.1 -8.1 -5.4 -10.9 1.7 -1.0 -1.6 1.1 -1.5 0.8 5.0 2.6 -1.1 3.6 15.9 -9.1 5.9 3.7 1.7 8.9 -9.3 -7.0 0.0 2.6 3.9 3.1

Octo ber 8. 1 6.4 -4.5 -0.3 -0.8 1.9 2.8 8.8 6.2 5.6 -0.4 1.5 3.5 -1.6 6.3 3.5 8.2 1.7 -12.5 -16.8 -1.9 -1.8 -1.7 3.8 7.0 10.9 1.6 -1.9 5.6 4.6

November 2.8 2.0 -1.5 -7.9 2.3 7.6 4.1 5.8 2.2 0.8 0.8 4.0 3.1 3.7 1.9 1.7 -3.6 -4.2 -8.9 -7.1 -1.2 6.0 -1.9 0.0 -0.6 -0.2 -4.5 0.6 0.2 3.0

December 9.8 5.9 2.3 0.5 6.5 0.9 -7.4 -5.8 -0.4 5.3 -0.2 3.4 -1.3 0.0 1.4 1.4 -4.3 -0.7 -4.0 1.1 5.5 1.9 0.5 6.7 0.1 1.0 0.1 0.9 3.9 2.5

YTD

TOTAL 31.0 21.0 -4.5 -9.1 16.5 -11.9 -22.2 -22.1 35.1 28.6 20.6 10.9 2 .6 4 .9 25.2 15.8 -3.2 5 .5 -18.1 -37.0 37.1 26.5 10.5 15.1 -24.9 2 .1 -1.7 16.0 16.8 32.4

20132012201120051999 2000 2001 2002 2003 2004 2006 2007 2008 2009 2010


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Appendix A

Why Theres More Downside to Come for InterOil

Whitney Tilson12/10/13http://seekingalpha.com/article/1887451-why-theres-more-downside-to-come-for-interoil

After InterOil announced its long-awaited asset monetization deal with energy supermajor Totalon Thursday night, the stock plunged 37% on Friday (before popping 10% today) because the

deal failed to meet investors overheated expectations. So is it time to declare victory on whatwas my largest short position and move on? No. Though I took some profits today, I maintain ashort position because I think theres more downside to come for InterOil.

Rather than engaging in breathless speculation about InterOils future (fueled by the mostclueless, conflicted analysts and venomous, anonymous message board trolls Ive encounteredin my career), its now possible at last!to analyze this company based on real information.Here are the links:

1. InterOils press releases and presentation (here,hereandhere)2. Totalspress release3. InterOils conference call (audiohereand transcripthere)4. The 80-page PRL 15 Sale Agreement that IOCfiledon Friday

The deal guarantees InterOil $613 million upon signing (expected in Q1 14), with twoadditional payments contingent upon the joint venture reaching final investment decision (FID),which Total expects in 2016 ($112 million), and first LNG cargo ($100 million), for a total of$825 million. Then, the remaining payments are mostly tied to how much gas (if any) there is inPRL 15 (the area covered by the agreement). Here is a table showing how much InterOil willreceived based on various resource levels:
http://seekingalpha.com/author/whitney-tilsonhttp://seekingalpha.com/author/whitney-tilsonhttp://seekingalpha.com/article/1887451-why-theres-more-downside-to-come-for-interoilhttp://seekingalpha.com/article/1887451-why-theres-more-downside-to-come-for-interoilhttp://seekingalpha.com/news-article/8383991-interoil-selects-total-sa-for-png-gas-developmenthttp://seekingalpha.com/news-article/8383991-interoil-selects-total-sa-for-png-gas-developmenthttp://seekingalpha.com/news-article/8383991-interoil-selects-total-sa-for-png-gas-developmenthttp://seekingalpha.com/news-article/8388961-interoil-announces-approval-of-prl39-by-the-png-government-and-clarification-on-the-transaction-with-total-s-ahttp://seekingalpha.com/news-article/8388961-interoil-announces-approval-of-prl39-by-the-png-government-and-clarification-on-the-transaction-with-total-s-ahttp://seekingalpha.com/news-article/8388961-interoil-announces-approval-of-prl39-by-the-png-government-and-clarification-on-the-transaction-with-total-s-ahttp://www.interoil.com/iocfiles/documents/investorrelations/presentationanddocuments/2013/2013-12-09%20Total%20Transaction%20Final.pdfhttp://www.interoil.com/iocfiles/documents/investorrelations/presentationanddocuments/2013/2013-12-09%20Total%20Transaction%20Final.pdfhttp://www.interoil.com/iocfiles/documents/investorrelations/presentationanddocuments/2013/2013-12-09%20Total%20Transaction%20Final.pdfhttp://total.com/en/media/news/press-releases/20131206-Papua-New-Guinea-Total-Enters-Two-Significant-Gas-Discoveries-in-the-Asia-Pacific-Regionhttp://total.com/en/media/news/press-releases/20131206-Papua-New-Guinea-Total-Enters-Two-Significant-Gas-Discoveries-in-the-Asia-Pacific-Regionhttp://total.com/en/media/news/press-releases/20131206-Papua-New-Guinea-Total-Enters-Two-Significant-Gas-Discoveries-in-the-Asia-Pacific-Regionhttp://www.interoil.com/conference-call-archives/2013-2/interoil-conference-call-interoil-selects-total-sa-for-png-gas-developmenthttp://www.interoil.com/conference-call-archives/2013-2/interoil-conference-call-interoil-selects-total-sa-for-png-gas-developmenthttp://www.interoil.com/conference-call-archives/2013-2/interoil-conference-call-interoil-selects-total-sa-for-png-gas-developmenthttp://seekingalpha.com/article/1883171-interoils-ceo-presents-at-selection-of-total-sa-for-png-gas-development-conference-transcripthttp://seekingalpha.com/article/1883171-interoils-ceo-presents-at-selection-of-total-sa-for-png-gas-development-conference-transcripthttp://seekingalpha.com/article/1883171-interoils-ceo-presents-at-selection-of-total-sa-for-png-gas-development-conference-transcripthttp://seekingalpha.com/author/whitney-tilsonhttp://seekingalpha.com/article/1883171-interoils-ceo-presents-at-selection-of-total-sa-for-png-gas-development-conference-transcripthttp://www.interoil.com/conference-call-archives/2013-2/interoil-conference-call-interoil-selects-total-sa-for-png-gas-developmenthttp://total.com/en/media/news/press-releases/20131206-Papua-New-Guinea-Total-Enters-Two-Significant-Gas-Discoveries-in-the-Asia-Pacific-Regionhttp://www.interoil.com/iocfiles/documents/investorrelations/presentationanddocuments/2013/2013-12-09%20Total%20Transaction%20Final.pdfhttp://seekingalpha.com/news-article/8388961-interoil-announces-approval-of-prl39-by-the-png-government-and-clarification-on-the-transaction-with-total-s-ahttp://seekingalpha.com/news-article/8383991-interoil-selects-total-sa-for-png-gas-developmenthttp://seekingalpha.com/article/1887451-why-theres-more-downside-to-come-for-interoilhttp://seekingalpha.com/author/whitney-tilson


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How this translates into fair value for InterOils share price is subject to many variables,including (my estimates are in parentheses): date of payments (as outlined in press releases),discount rate (10%), minority interests (40%), value of InterOils refinery ($200 million), valueof Triceratops and other assets ($500 million), the companys overhead ($25 million annually),net debt levels (constant) and share count (51 million). Using these estimates and then plugging

in a range of possible resource levels (the latter five are the ones in InterOils press releases), Icome up with a fair value for the stock today ranging from $11 to $98, as this table shows:

The current share price of $61.13 is near the middle of this range, so does that mean the stock isroughly fairly valued? I dont think so because I dont believe these scenarios are equally likely.

Ive long believed that there was only a small say, 20%chance that PRL 15 would ever yieldany economically producible gas for reasons that are summarized well in these four reports:

1. InterOil (IOC): "Major Momentum" Or Just A Castle In The Air? (clickhere;focus onthe history section, which documents the many energy companies that have exploredPRL 15 for more than 50 years without success, and the geology section, which explainswhy: There were no sustainable hydrocarbon flowsjust a spectacular initial flowfollowed by failure.)

2. Presentation by Lakeview Investment Group (clickhere)3. A write-up on ValueInvestorsClub.com (clickhere;log in as a guest)4. InterOil: Three Strikes, You're Out, And A Beanball To The Head On The Way Back To

The Dugout?(clickhere)

But doesnt the deal with Total, which guarantees InterOil $613 million up front, prove that theremust be at least some economically producible gas in PRL 15? Not necessarilythough it doesimprove the odds (see below). Total is one of the worlds most profitable companies, so $613million represents a mere 2.2% of its $28 billion in pre-tax income in the past year. Thus, it mayview the deal with InterOil as a cheap call optionperhaps worth nothing, but a risk offset bythe potential large upside.

If I were to guess, I think Total would ascribe the following probabilities to the range ofoutcomes for PRL 15:
http://www.businessinsider.com/interoil-ioc-major-momentum-or-just-a-castle-in-the-air-a-new-investigation-2010-4?op=1http://www.businessinsider.com/interoil-ioc-major-momentum-or-just-a-castle-in-the-air-a-new-investigation-2010-4?op=1http://www.businessinsider.com/interoil-ioc-major-momentum-or-just-a-castle-in-the-air-a-new-investigation-2010-4?op=1http://www.gurufocus.com/news/198588/lakeview-investment-group-short-interoil-presentation-from-invest-for-kidshttp://www.gurufocus.com/news/198588/lakeview-investment-group-short-interoil-presentation-from-invest-for-kidshttp://www.gurufocus.com/news/198588/lakeview-investment-group-short-interoil-presentation-from-invest-for-kidshttp://www.valueinvestorsclub.com/value2/Idea/ViewIdea/77689http://www.valueinvestorsclub.com/value2/Idea/ViewIdea/77689http://www.valueinvestorsclub.com/value2/Idea/ViewIdea/77689http://seekingalpha.com/article/1664602-interoil-three-strikes-youre-out-and-a-beanball-to-the-head-on-the-way-back-to-the-dugouthttp://seekingalpha.com/article/1664602-interoil-three-strikes-youre-out-and-a-beanball-to-the-head-on-the-way-back-to-the-dugouthttp://seekingalpha.com/article/1664602-interoil-three-strikes-youre-out-and-a-beanball-to-the-head-on-the-way-back-to-the-dugouthttp://seekingalpha.com/article/1664602-interoil-three-strikes-youre-out-and-a-beanball-to-the-head-on-the-way-back-to-the-dugouthttp://www.valueinvestorsclub.com/value2/Idea/ViewIdea/77689http://www.gurufocus.com/news/198588/lakeview-investment-group-short-interoil-presentation-from-invest-for-kidshttp://www.businessinsider.com/interoil-ioc-major-momentum-or-just-a-castle-in-the-air-a-new-investigation-2010-4?op=1


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If so, the resulting expected value for InterOils stock, using the share price estimates above, is$44.

But I think these probabilities are much too high and would instead estimate the following:

If these probabilities are correct, the resulting expected value for InterOils stock is only $31.45,barely half of yesterdays closing price of $61.13 which is why I remain short the stock.

So whos right: one of the worlds largest energy companies, with vast experience and resources,or little ol me? While it sounds like the height of arrogance to say so, I think I am. Bigcompanies do dumb things all the time. Remember when HP announced in April 2010 that it was

acquiring Palm for $1.2 billion in cash? That very day I went on CNBC and said it was a bone-headed acquisitionand was eventually proven right.

Ive been short InterOils stock for more than four years and have been closely following thecompany even longer. In contrast, I suspect that Total has only been looking seriously at InterOilfor the past few months, given that for most of this year, InterOil was in exclusive negotiationswith Exxon. In addition, InterOil over the years has been rumored to be on the verge of a dealwith a nearly endless parade of partnersbut Totals name rarely came up. In March 2009 aReuters story mentioned Total, and since then InterOil, its analysts, and the media havementioned 19 other potential partners!

By far the most logical partner for InterOil is Exxon, which has a $19 billion LNG project on theverge of completion, with scheduled shipments to begin next year. The economics of Exxondoing a brownfield expansion are far superior to Total building a greenfield liquefaction terminalso, naturally, all of the focus has been on Exxon. Despite its superior economic position,however, Exxon wasnt even willing to match the disappointing deal InterOil agreed to withTotal. This fact pattern certainly lends credence to the notion that Total doesn't have a clue


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and/or is taking a gamble as it struggles to replace reserves (a problem many of the supermajorsare grappling with). As a result, I think Total is likely flushing $613 million down the drain.

Anarticlein the Wall Street Journal in July offers some clues to what I think happened. It notesthat Exxon's $19 billion project, dubbed PNG LNG, is among the more advanced in Papua New

Guinea, whereas Totals foray into Papua New Guinea has gotten off to a shaky start, with twoexploration wells yielding only "modest" amounts of natural gas. Having struck out on theirown and under pressure to, in general, build reserves and, specifically, catch up with Exxon inPNG, I wouldnt be surprised if we later learn that Total rushed its due diligence and convinceditself that PRL 15 is a major resource when, in reality, theres no economically producible gaswhatsoever.

To see what I think will happen to InterOil, look at OGX, a heavily promoted energy company inBrazil that is now in bankruptcy with its shares down 99% from their peak. This Bloombergarticlesummarizes OGXs history:

OGX was founded in 2007 and raised $1.3 billion from private investors to buy oilconcessions in November of the same year, a month after state-run Petroleo BrasileiroSA, or Petrobras, announced the discovery of a giant offshore oil province south of Riode Janeiro.

Seven months later, Batista raised 6.7 billion reais ($4.1 billion) for OGX in an initialpublic offering in what was at the time the biggest IPO in Brazilian history.

A year after that he was drilling wells. A period of rapid success in finding oil led OGXto briefly outstrip Petrobras as the most successful explorer in Brazil by strikes registered.

OGX pumped its first oil in January 2012, but by mid-year it became clear that the fieldwould not produce near expectations and the company's stock began a drawn-out decline.

In the last year alone, OGX's share price has plunged about 95 percent

I think well eventually learn that, like OGX, InterOils PRL 15 field will not produce nearexpectations and that InterOilsstock will suffer a drawn-out decline.

That said, we wont know anything for sure until the appraisal wells are drilled and the resourceis certified (or not), which might not happen until 2015. Until then, InterOil bulls may be able topump this stock up once again, so Id advise short sellers to size this position small for now andlook to ramp it up shortly before the results of the appraisal wells are released. At that point, ifthe results are as dismal as I expect, the stock will collapse.
http://online.wsj.com/news/articles/SB10001424127887323829104578623262362557112'http://online.wsj.com/news/articles/SB10001424127887323829104578623262362557112'http://online.wsj.com/news/articles/SB10001424127887323829104578623262362557112'http://www.reuters.com/article/2013/10/30/us-brazil-batista-idUSBRE99T19620131030http://www.reuters.com/article/2013/10/30/us-brazil-batista-idUSBRE99T19620131030http://www.reuters.com/article/2013/10/30/us-brazil-batista-idUSBRE99T19620131030http://online.wsj.com/news/articles/SB10001424127887323829104578623262362557112'


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Appendix B

My Analysis of Lumber Liquidators Updated Guidance

Whitney Tilson12/10/13http://seekingalpha.com/article/1887441-my-analysis-of-lumber-liquidators-updated-guidance

After the close yesterday, Lumber Liquidators updated its guidance (see press releasehere)andreleased a new investor presentation (here). I believe this new information provides evidence to

support the key pillar of my investment thesis (outlined in my original presentation, postedhere):that margins will come under pressure, leading Lumber Liquidators to miss the exuberantexpectations built into the stock price.

While LL increased its prior guidance for Q4 and 2014, it missed current consensus analystestimates. Specifically:

For Q4

Net sales of $252-$258 million; the midpoint, $255 million, is exactly the currentconsensus

EPS of $0.69-$0.72, below the current consensus of $0.73 Incremental SG&A of $1.8-$2.3 million, up $0.4-$0.5 million from prior guidance due to

the start-up of the West Coast distribution center and certain incremental legal andprofessional fees (interestingly, on page 5 of the investor presentation, the language isdifferent: the start-up of the West Coast distribution center and certain incremental legaland professional fees associated primarily with regulatory matters, including the LaceyAct investigation, and the continued enhancement of our compliance programs exactlythe areas I highlighted that would cause expenses to rise and margins to fall)

Most importantly, LL guided to materially lower gross and operating margins relative toQ3 and the trend over the past 2+ years, as this chart shows:
http://seekingalpha.com/author/whitney-tilsonhttp://seekingalpha.com/author/whitney-tilsonhttp://seekingalpha.com/article/1887441-my-analysis-of-lumber-liquidators-updated-guidancehttp://seekingalpha.com/article/1887441-my-analysis-of-lumber-liquidators-updated-guidancehttp://finance.yahoo.com/news/lumber-liquidators-updates-outlook-conjunction-220500832.htmlhttp://finance.yahoo.com/news/lumber-liquidators-updates-outlook-conjunction-220500832.htmlhttp://finance.yahoo.com/news/lumber-liquidators-updates-outlook-conjunction-220500832.htmlhttp://investors.lumberliquidators.com/index.php?s=19&item=11http://investors.lumberliquidators.com/index.php?s=19&item=11http://investors.lumberliquidators.com/index.php?s=19&item=11http://www.tilsonfunds.com/LL.pdfhttp://www.tilsonfunds.com/LL.pdfhttp://www.tilsonfunds.com/LL.pdfhttp://seekingalpha.com/author/whitney-tilsonhttp://www.tilsonfunds.com/LL.pdfhttp://investors.lumberliquidators.com/index.php?s=19&item=11http://finance.yahoo.com/news/lumber-liquidators-updates-outlook-conjunction-220500832.htmlhttp://seekingalpha.com/article/1887441-my-analysis-of-lumber-liquidators-updated-guidancehttp://seekingalpha.com/author/whitney-tilson


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(Note that while LL gave Q4 gross margin guidance of 40.4-40.7%, it didnt giveoperating margin guidance. I estimated a range of 12.5-12.8% based on the average of12.4% for all of 2013see page 31 of the investor presentation.)

For 2014

Net sales of $1.15-$1.2 billion, in line with the current consensus of $1.16 billion EPS of $3.25-$3.60; the midpoint of $3.43 is below the current consensus of $3.50 Operating margin of 13.0-13.8%, up from 12.4% for all of 2013

This guidance would be fine if the stock were trading at 15-20x earnings (which is where itwould be trading if the market were rational), but at yesterdays closing price of $103.80, thestock is trading at 38x the midpoint of 2013 estimates and 30x the midpoint of the new 2014guidance.

Such nosebleed multiples can only be sustained by companies consistently beating estimates andraising guidancewhich is what LL had been doing for the past two years, leading to a nearly 7xrise in its stock. But LL just missed and loweredand for precisely the reasons I outlined.

As investors wake up to LLs new reality, I think the stock drifts lower until the next earningsreport in the third week of February, at which point the company will update 2014 guidance. Iexpect even weaker guidance for the year at that time, as I think its highly unlikely that LL canincrease its operating margin from 12.4% in 2013 to the 13.0-13.8% its now promising for2014. Rather, I think operating margin will be flat to down, which spells big trouble for thestock.

For those of you who really want to dive into the weeds, LLs latest investor presentationincludes a number of new and updated slides that aim to address the many issues Ive raised see the appendix below for the highlights. LL is very clever in presenting information whichmakes the case that even if the Environmental Investigation Agencyreportis correct, it focuseson only one supplier, which the company can simply stop sourcing from with minimaldisruption.
http://eia-global.org/campaigns/forests-campaign/liquidating-the-forests/http://eia-global.org/campaigns/forests-campaign/liquidating-the-forests/http://eia-global.org/campaigns/forests-campaign/liquidating-the-forests/http://eia-global.org/campaigns/forests-campaign/liquidating-the-forests/


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Im skeptical that this is an isolated problem limited to one rogue supplier. Rather, I believe thatLumber Liquidators has a big problem on its hands due to the combination of a) the evidence inthe EIA report, b) the unusually rapid increase in Lumber Liquidatorss margins tounprecedented levels immediately after acquiring a Chinese supply chain company, and c) thehugely corrupt business environment in both Russia and China. Though I cant prove it, the

evidence I see, combined with common sense, makes me think its highly likely that what EIAhas uncovered is a pervasive problem across Lumber Liquidatorss Chinese supply chain.

Since the raid, the company is surely scrambling to show the authorities that whatever problemsare in their supply chain are isolated cases, they didn't know about it, etc. But keep in mind thatthe authorities raided Lumber Liquidators based on the EIA report, so they're not going to beeasily fooled by some spin and token actions. Rather, I think Lumber Liquidators right now hasno choice but to very quickly clean up its act to avoid major sanctions by the authorities.

Specifically, I think Lumber Liquidators will have to: 1) immediately stop sourcing fromsuppliers they even suspect are trafficking in illegal wood; 2) find replacement suppliers; and 3)

ensure their entire worldwide supply chain is pristine. Doing all of these things is likely to bevery costly and disruptive to the businessnot to mention management being distracted byhaving to deal with the authorities for the foreseeable future.

Yesterdays updated guidance reinforces my belief, so I maintain my $53 price target (and Ithink Im being generous), which is based on the following back-of-the-envelope math:

Sales grow 16% annually in the next two years, as analysts expect (resulting inrevenue of $1.35 billion)

Operating margins give back half of the 830 basis point increase in the last ninequarters and fall to 9% (still far above the long-term average)

The market responds to this by assigning the stock a 20x P/E multiple Result: $1.35B x 9% - 39% tax rate / 28M shares = $2.65 EPS x 20 = $53

AppendixHere are my comments on the latest investor presentation:

1) This was the slide in the prior investor presentation (dated 8/14/13; postedhere)showing thesources of gross margin improvement:
http://investors.lumberliquidators.com/index.php?s=19&item=8http://investors.lumberliquidators.com/index.php?s=19&item=8http://investors.lumberliquidators.com/index.php?s=19&item=8http://investors.lumberliquidators.com/index.php?s=19&item=8


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This is the new version of it:

Notice how theyve carefully removed any mention of buying product for less instead itseliminate markup and eliminate middlemen.


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2) In slide 21, Our Sourcing, LL repeats that No single supplier provides more than 4% of ourhardwoodpurchases and No single hardwood product represents more than 1% of our salesmix. In addition, theres new language here:

Mills go through an on-boarding process and regular reviews of performance

Since the fourth quarter of 2011, we have replaced 50% of the Asian millsexisting at that time, yet doubled the net total number of mills to reduce risk bydiversifying our supply base

In any given year, we expect mill turnover to range from 15% to 30%, yetcontinue to broaden the number of mills supplying flooring products

3) On slide 22, LL highlights again that hardwoods are declining as a percentage of sales (nowdown to 43%, from 47% in 2012 and 64% in 2008).

4) Slide 23 is a new slide on sourcing mix, showing an Increase in Asian sourcing wherebamboo and Acacia hardwood grow, and where laminate, engineered and handscraped hardwood

products are cost-effective to produce.

5) Slide 24 aims to show how insignificant Asian hardwood is in LLs supply chain:

6) Slide 25 addresses the formaldehyde issue: Our emissions compliance policies andprocedures are designed to go above and beyond regulatory requirements and make our products,whether sold in California or any other state/country, compliant with CARBs wood productformaldehyde emission standards.


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7) Slide 31 shows the expansion in operating margin, but adds three more years and adds thisbox that reads: SAP Implementation in August 2010: Full Productivity Restored in 2H 2011.In other words, operating margin fell as the new SAP system was installed, and then expanded asthe benefits of the system kicked in. Heres the slide from August:


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And heres the new one:


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The T2 Accredited Fund, LP (dba the Kase Fund) (the Fund) commenced operations on January 1,1999. The Funds investment objective is to achieve long-term after-tax capital appreciationcommensurate with moderate risk, primarily by investing with a long-term perspective in a concentratedportfolio of U.S. stocks. In carrying out the Partnerships investment objective, the Investment Manager,T2 Partners Management, LP (dba Kase Capital Management), seeks to buy stocks at a steep discount tointrinsic value such that there is low risk of capital loss and significant upside potential. The primary

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It should not be assumed that any of the securities transactions, holdings or sectors discussed were or willprove to be profitable, or that the investment recommendations or decisions we make in the future will be

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Performance results shown are for the Kase Fund and are presented net of all fees, including managementand incentive fees, brokerage commissions, administrative expenses, and other operating expenses of theFund. Net performance includes the reinvestment of all dividends, interest, and capital gains.

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