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Collection: Mohnish Pabrai - #78 'Risk and Uncertainty'



The question was how do you disentangle risk from uncertainty?


Risk and uncertainty are two different things.

And one of the things that works to the advantage of investors is that market hate uncertainty. So market will really punish companies which have uncertain outcomes. And you know, it's always fun to play these uncertainties games.

So let me give you a real example which is in my portfolio right now. So there's a company called WL Ross & Company, the ticker is WLRH. And it was set up by Wilbur Ross. And it's a blank check SPAC company basically where they raise what 500 million and pretty much all the cash is sitting there.

And they have to do a deal in a couple of years and if they don't do a deal in couple of years then the cash comes back to investors. And so in fact the unusual thing about the Wilbur Ross company is that even the investment banker underwriting fees get refunded in the event the money is send back. So you know, they are the guys who did all the work for the IPO and such, most of that will come back too.

So basically, you know, the company has pretty much $10 a share in cash and the stock is at $10. And in fact when we bought any time, it went below $10. In fact, we usually bought it below $9.97 so that even with commission we were below $10. And so we were buying a dollar bill for slightly less than a dollar bill in that case.

And Wilbur Ross is a tremendous value investor. He is, you know, I would say deep distress value. And so the uncertainty in that stock is we have no idea what business Wilbur Ross will invest in or what industry he will invest in or what that economics of the investment will be?

We also don't know whether he's going to fail to make the investment in which case the money comes back to us. And so there's a lot of uncertainty in that stock, but when you look at risk, the risk is for the most part non-existent.

Today there isn't much risk because you got cash against what you pay. And how would you lose money? Well, you will lose money if Wilbur made an investment that ended up being a bonehead investment where it turned out to be terrible.

And the batting average of Wilbur Ross is so good that I would say that the odds that you have a significant permanent loss of capital in an investment that he would make is very low.

And there's another ticker with the same stock which is WLRHU, which is – gives you a share of stock and also gives you the option to buy another half share. I think at like, the equivalent of $11 a share or something, so that has a kicker in it as well. So this is an example of risk being low, uncertainty being high and market is not liking that right?

There was another company, I had invested in a long time back. In fact, this was my first investment I made when we first started Pabrai Fund in July 1999. And it's called Silicon Valley Bank.

And Silicon Valley Bank was – still is – a bank in Silicon Valley, very well-run bank that mainly makes kind of asset-backed loans to venture-backed companies. But the unusual things about them is that usually when they make those loans, they also get warrants attached to those loans.

So, you know in Silicon Valley if you're a masseuse at Google, you're going to get stock options. And so nobody raise eyebrows and your banker say, hey I made you a loan can you give me some stock options? And even the waiter at [Inaudible] think he should get a [Inaudible] in stock options.

And so they had in July of 1999, hundreds of stock options and hundreds of these dot coms, and they have no disclosure around those. Now the bank was profitable and doing well assuming those warrants were worth zero.

And in the valuation that have been given to the bank, there was really no value being ascribe to those warrants. People didn't know which companies they had, they didn't know how much they had and they didn't know what the strike prices were, there was no disclosure.

But the idea is that it was all about zero. You know, the lowest price it could be is zero and the odds are pretty high with this huge bubble that was being fuelled. I was looking for a way at that time in 1999 to get upside with the bubble without the downside. And what a beautiful way to play that bubble with Silicon Valley Bank where you get the base bank, which is solid and then you have this, you know, unknown moonshot applied to it. And I think we had a 3 or 4X in Silicon Valley Bank in a year that we held it.

And what happened is a few months after I bought, the bank started to realise, they had, you know, gorp of assets in these warrants. And I think those sedate bankers probably decided that they didn't like to see all that sitting there illiquid.

So as soon as they were able to when these companies went public whatever, they started unloading those warrants. And as they unloaded that started to hit income statement. And as it started to hit income statement then they started to give disclosure, the stock started to react and such.

So that was another example of upside without downside where you go with uncertainty and risk was low there. Risk is low with WLRH and uncertainty is high. It's a good arrow to have in your quiver.



[YAPSS Takeaway]

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