A Wild Week in Review: Some Musings on Asymmetry and Capturing Right Tails

TIL, FTCI, CPH.TO, MOB.ST

Disclaimer: Nothing on this blog is intended as financial or investing advice. Please do your own due diligence.

Within the rolodex of terms value investors love to ceaselessly and obnoxiously pontificate about — compounding, intrinsic value, moats, etc. — the notion of “asymmetry” may perhaps be the most ubiquitous, yet misapplied. Naturally, we all believe our ideas have asymmetric upside — i.e. the expected distribution of returns skews positive — but the reality is that many of us tend to overestimate the thickness of the right tail whilst underestimating the left tail. This obviously occurs because the world is far too multivariate and complex for our fallible, bias-riddled minds to accurately appraise.

Notwithstanding all of that, the reason a truly disciplined approach to investing should produce positive returns over time is that asymmetry is inherently built into the game — assuming no leverage or shorting, the most you can ever lose is the money you put in, while your upside is uncapped and theoretically infinite. In short, despite our innate mental limitations, the parameters of the game are actually rigged in our favor. While trite, this truth raises a depressing inquiry: why, then, do so many of us fail to achieve long-term compounded returns superior, or at least equal, to the market average?

Among many other reasons: because we are disposed towards behaviors that actively undermine this advantage.

• We cut-off the right tail by selling too early. Even the best investors are going to be wrong a lot, if not most, of the time. To make-up for our paltry “batting-averages”, we need to facilitate obtaining a high “slugging percentage” — i.e. by making sure that we maximize our upside when we do get it right. This only works if we let our winners run, which in turn requires we adopt discipline (resistance) towards profit-taking. Bill Miller has eloquently espoused this sentiment:

“Part of what people insufficiently distinguish, or confuse, is the difference between frequency and magnitude — that is, how often you’re right or wrong versus how much money you make when you’re right and how much money you lose when you’re wrong. Most people look for a high batting average — high frequency of being right. And most of the time when they do that, they have what is known in philosophy as a “high epistemic threshold.”’ They need a lot of information and a lot of stuff to convince them that they are right.

As a result, they focus on how often they are right and not on how much money they make when they are right. They might make 10 – 20 percent when they are right. But then, of course, they’ve got to reinvest. Mathematically, if they make one significant error, it will offset a lot of instances where they were right.

We focus not on our batting average, to continue the baseball metaphor, but on our slugging percentage. So, if we have a few investments where we make 5 or 10 times your money — or as we did in Dell and AOL, 50 times your money — that pays for a lot of mistakes. It pays for a lot of misses of 10 percent or 20 percent.”

• Inadequate concentration/position sizing. To that same end, it’s not enough to simply pick a winner and let it run. We need to size the position intelligently. Putting 1% of your capital into a high conviction position that ends up multi-bagging is a great way to inflict psychological torment on yourself (speaking very much from experience).

• Poor risk management. This is perhaps a broader, overarching principle that largely informs and ties together everything just discussed. While the contours of investing are positively skewed, we obviously only stand to benefit from this if we have chips left on the table to play with. The problem, as I see it, is that our efforts to maximize our ‘slugging percentages’ (e.g. concentration, not taking profits), despite being the correct orientation, perversely often make us susceptible to precipitous declines if we are not extremely disciplined about risk management. This is why, for example, Joel Greenblatt, who famously ran extremely concentrated, constantly discusses concentration as a function of downside, rather than upside: “My largest positions are not the ones I think I’m going to make the most money from. My largest positions are the ones I don’t think I’m going to lose money in.” Again, this is largely trite and most of us, at least implicitly, understand this idea. The difficulty, as I will highlight in an example below, is that it’s easy to delude ourselves into seeing a margin of safety that turns out to not be nearly as wide as we envisioned once the unforeseeable vicissitudes of business have their way. It’s helpful, as a result, to have a hierarchy of criteria to reference when assessing the quality and fortitude of a margin of safety.

The impetus for sharing these thoughts stems from an extremely unusual week I just experienced in the market, with major moves in several positions that I think serve as interesting case studies on the topic of asymmetry, and my efforts, successful or not, to capture it.

Instil Bio - A mistake, or the unavoidable cost of discipline?

We are psychologically wired towards taking action. And while that cognitive inclination may have its advantages from an evolutionary perspective, it is a bias we constantly need to fight against as investors, particularly as it relates to selling. One way I try to resist the urge to sell too early is to think of a long position in a stock as an open ended call option — there is no time decay, only opportunity cost — on the unlimited upside that might arise from positive, unexpected developments materializing.

Enter Instil Bio.

Subscribers may be familiar with this company, which I first pitched in January (closed at breakeven in March after the thesis appeared broken) and then again in July (after the thesis appeared back in play). For those not aware, the thesis was very simple: Instil was a broken biotech that outsourced development of its lone remaining candidate to a Chinese company, effectively terminated its operations, and was trading at an enormous discount to liquidation value due its large pile of net cash and ownership of a 128K SF life sciences building in California. My base case was this real estate would eventually be sold and the capital would be returned to shareholders through a liquidation, or otherwise used to facilitate a reverse merger, etc. Given a conservative 55% discount to NAV, this was truly a robust margin of safety and thus it warranted a position despite the uncertainty and opportunity cost of waiting.

But then something unexpected happened. On August 1, the company announced it was in-licensing ex-China development to a PD-L1xVEGF bispecific antibody. My reaction was twofold: 1) what on earth is a PD-L1xVEGF bispecific antibody?; and 2) I was frustrated, as the deal both took a return of capital off the table (at least for the time being) whilst also reducing tangible liquidation value due to the $50m upfront payment to secure the asset.

I was inclined close the idea out for a second time given this company was making it very clear that they had no intention of throwing in the towel as I had hoped. However, given the stock was still trading at a huge discount to liquidation value I figured I’d hold on and monitor the situation — there was sufficient cushion to protect us from any stupidity and absent aggressive cash burn, we were getting a free call option on the asset.

Then one of the craziest right tail events I have ever seen unfolded.

Last Sunday, Summit Therapeutics announced strong late-stage data from its PD-L1 candidate, which provides a read through to the viability of Instil’s product. On Monday, TIL shares soared 40% to close at $22. With the stock now up ~80% since pitching it at $12.70 two months prior and trading above liquidation value given the $50m cash outlay, as well as my having literally zero insight into the PD-L1 space, I wrote to subscribers noting I was selling ~65% of my shares, but keeping the remainder open given what was likely more upside to come.

And I was correct. Over the next two days, the stock continued its rapid ascent. On Wednesday, I wrote subscribers again, noting I was selling the majority of the remaining position at $31.40, and officially closing the idea out for the purposes of the blog given my thesis (e.g. an asset play) was completely broken (sometimes a broken thesis is actually a good thing!) and that I simply wasn’t able to offer any educated thoughts about the PD-L1 space and surely wasn’t going to get up to speed on it any time soon. In my view, even if I was leaving a lot of upside on the table, continuing to hold would be undisciplined and far more akin to speculation than investing. Besides, hard to complain about a low risk net-net returning 150% in two months, right?

Well, I did indeed leave a lot of upside on the table. Over the next two days, the stock tripled(!!!) and closed the week out ~$90/share.

The portion of my position that I have not yet sold is now up >600% in a mere two months. That’s great, but I sold the vast majority of that position many bags ago.

While it obviously hurts in the abstract to miss out on GameStop 2.0, I’m not particularly bothered by it and don’t think I made a mistake here despite my thoughts at the opening of this piece about not cutting off the right-tail too early. The way I see it is that rational decision-making within a portfolio is always premised on the necessary pre-condition that you understand what you own; absent that condition being satisfied, any good outcomes are merely luck and over time will surely be overwhelmed by poor results. Had my Instil thesis been based on the prospects for PD-L1xVEGF, I’d be incredibly frustrated selling where I did; but having not the slightest clue what PD-L1xVEGF is, I consider myself lucky to have made the money I did on this idea as it is.

FTC Solar - did discipline in not selling cost me this time?

(Also, always pay attention to insiders!)

On to another interesting case study and what is broadly a very unusual situation.

A couple weeks back, I came across a company called FTC Solar (FTCI). The company provides solar trackers (mechanical systems used in solar installations to adjust the orientation of the solar panels throughout the day to maximize sunlight exposure) for use in utility-scale solar projects.

It’s certainly not a great business: on one hand, it’s exposed to demand from project developers who face a complicated backdrop; on the other hand, it’s exposed to volatile input costs and challenges faced by its third party manufacturers. Beyond that, the business has been historically mismanaged, some insiders have questionable reputations, and despite no financial debt, a first glance at the financials suggests an imminent shortfall to fund its cash burning operations, and thus a likely dilutive raise. It also faces Nasdaq delisting due to falling well below a $1 as the stock has been completely hammered since its IPO in 2021 (shares were approximately $0.23/share at the time I came across it).

Despite this, there were a couple really interesting things that caught my eye:

• Insiders have been gobbling up shares, in size, on the open market for months (look at all those Form 4s!) including purchases at more than 2x the current share price. And these aren’t just any insiders, but rather 1) the co-founder of the company, who runs a solar investing fund, and is obviously intimately familiar with the company and the sector; and 2) a former director who resigned on August 15 but has oddly continued purchasing stock since his departure;

• The company hired a new CEO at the end of July who has a lot of experience operating far larger companies in the solar space. That is interesting on its own, but what really caught my eye is his compensation agreement. In addition to a base salary of $650K, he was granted 6.5m Restricted Stock Units, 2.5m of which vest subject to share price hurdles: 30% upon obtaining a $5 stock price, 30% upon obtaining $8, and 40% upon obtaining $10. The stock was in $0.40/share range when granted, meaning the stock needed to ~12x just to trigger the first threshold. This is so crazy that I was convinced something nefarious is going on: e.g. my first thought was that there might be some legal clause indicating that these price targets will not adjust upon a reverse split, and thus, e.g., a 1 for 10 split (likely, given the delisting notice) would result in gifting him a huge chunk of the company with a far lesser hurdle. But having reviewed that legal documents, that does not seem to be the case (I could be missing something). Moreover, one wonders why on earth board members would be loading up on 6-7 figures worth of stock (they also already own >20%) if they were about to be diluted into oblivion. (If someone knows what I’m missing here please let me know).

• The company boasts a backlog of $1.8B, and a contracted backlog of ~$500m (>10x the market cap). Backlogs tend to be black boxes, but the aggressive insider buys in advance of this strongly suggest that this backlog is going to lead to a material inflection in earnings, doesn’t it?

• It would not take much for this to become a multi-bagger. Management represents that the company will be EBITDA positive during 2025, which requires $240m of full year sales. Merely applying a 1x sales multiple to that results in $1.90/share, or >750% upside from my low $0.20s entry price. On the other hand, despite dwindling cash, working capital appears sufficient to fund operations into 2025 without dilution — a sentiment fortified by the insider buys. Moreover, with no financial debt, a large back log, and shares trading at net working capital, the downside seems decently protected.

Altogether, despite low quality and a lot of hair, I figured it was worth a position, particularly given the insider buying. I started building a position on Monday and into Tuesday.

And voila, another right tail outcome. On Tuesday, right at the close, the company announced a muti-year agreement to supply 500 MW of solar tracker technology, which could extend to 1GW. This is a big deal: since 2017, FTCI has delivered 4.5GW of trackers, meaning this contract alone should be worth between ~10-20% of total volume the company has done in its entire history. And at industry rates of between 9-13 cents/watt, the deal is worth at least $45m of revenue and likely a lot more.

As soon as the deal hit the wire, shares surged from $0.23 to as high as $0.70 in after hours, and I was quickly up ~220% on my investment in effectively one day. Given, however, the pricing and volume of the insider buys, the RSU vesting targets, the size of the backlog (which IR confirmed with me does not include this new contract), and the fact this contract almost surely takes a dilutive raise off the table, I opted to not sell any of my shares.

Of course, unlike TIL, FTCI shares have given much of this upside back in the ensuing days, closing the week at $0.37 — good for 68% on my cost basis in a week, but a far cry from >200%.

I’m doing my best to not think about how much higher my net worth would be had I sold FTC on Tuesday and held TIL through the week…

[By the way, if anyone is familiar with FTCI and is willing to share some thoughts I would greatly appreciate hearing from you. And please, for anyone whose interest might be piqued by this idea, use extreme caution. There’s probably a good reason this trades where it does —it’s a cash burning illiquid penny stock with red flags and black boxy operations. I’m highlighting this company as an intellectual curiosity, not as a pitch, at least not yet. Regardless, DYODD as always.]

Cipher, Moberg, Position Sizing, and the Importance of a Real Margin of Safety

Okay, now on to this week’s microcap fintwit fiasco, Moberg Pharma, which has, naturally, led to denial and thesis drift from bulls, grave-dancing and hindsight bias from bears, and of course, the compulsion of those with no horse in the race to proffer ill-conceived opinions.

Some context for those unfamiliar.

One of the first ideas I published on this blog was Cipher Pharmaceuticals. The stock, which I started buying in the $3 range a couple years back, has been a really big success for me (and many others), hitting a high of $19.69 in late August. Due to this price appreciation and additional purchases along the way, it has grown into my biggest holding at >20%. As many of you know, Cipher boasts an increasingly diversified product of highly sticky and cash generative dermatology products. Additionally, the company owns the Canadian rights to a number of products with ongoing clinical trials, including the topical nail fungus treatment MOB-015, which is owned and being funded by Swedish biotech Moberg Pharma. Cipher stands to see its earnings multiply if this product comes to market in Canada.

Due to Cipher’s exposure to this product, many Cipher longs, including myself, have taken a position directly in Moberg, which has retained the rights to the US. Although MOB-015 has already received approval throughout much of Europe and is already commercialized (and rapidly taking market share) in Sweden, the product is currently undergoing Phase 3 trials in the US because (as the result of a decision which in hindsight has turned out to be disastrous) the company hopes(hoped?) to demonstrate an improved “complete cure” rate through altered application, which would improve the product’s label and potential to capture market share.

Based on what could have been enormous upside had Moberg achieved its goal in the US, a decent probability of success in P3 due to prior approval in Europe, and some factors that made this less binary than the ordinary biotech - e.g. cash and milestones and future royalty earnings from Europe and RoW, I thought the risk/reward was good enough to warrant ~4% position at ~19SEK/share in March of this year.

In the months since that time, I have had a ton of inbounds inquiring into why I have sized Cipher so much larger than Moberg — after all, if Moberg works, isn’t the upside much higher than Cipher’s? Those inquiries have accelerated as Cipher has run up — shouldn’t you think about rolling some of Cipher into Moberg given the former has already played out to a large extent?

Those were absolutely fair and understandable questions. Going through some of my answers, they were probably often too long and rambling — it would have sufficed to simply drop the Greenblatt quote referenced above: “My largest positions are not the ones I think I’m going to make the most money from. My largest positions are the ones I don’t think I’m going to lose money in.”

While hindsight is 20/20, the reality is that Moberg was always going to be exposed to left-tail risk, both from the P3 trial but also from this subscale and historically terribly managed company’s efforts to actually execute on US commercialization even if the trials did work (the signs were there). Here’s what I wrote to a subscriber a few weeks ago in connection with this:

“On the other hand, with Moberg, you're buying that asset on its own (albeit for very cheap if it does work out) and you've got no real operating biz and a capital allocation background that concerns me. There's a lot more left tail risk, imo, though the right tail is fatter as well. In short, I think MOB will work out, and I do own some, but I can sleep a lot better having 1/4 of my portfolio in Cipher than I ever could with Moberg, and I still think Cipher could be worth multiples in the next couple years with less downside.”

On Friday, that left-tail risk emerged, with Moberg announcing that it was “lowering expectations” on the primary endpoint for its Phase 3 US trials. Shares collapsed 61%, closing the day at 11.23SEK/share. After being up ~100% on this position, I’m now down ~40% on my cost basis and have taken a ~2% ish hit to my NAV. That obviously sucks, but a couple hundred basis points isn’t something I’m losing sleep over. (For what it’s worth, I also tend to think this sell off is probably overdone, but that’s for another day).

Much more important for my portfolio is Cipher, which going into Friday was nearly 1/4 of my portfolio and several multiples larger than my Moberg position. Well, after opening with a gut wrenching and completely unhinged 35% drop to open on Friday, shares had nearly a 50% intraday retracing and closed down ~13%. But here’s the thing: even that 13%, which is a lot less catastrophic than 61%, is surely way over done. Leaving aside the fact that this Moberg Phase 3 trial does not outright kill Cipher’s ability to sell the product in Canada (I’ll probably have more to say on that later this week), Cipher, in my mind, has never even been priced at all for the Moberg opportunity. Indeed, at the current share price, I estimate Cipher is conservatively trading at 8x EBITDA in a year or two (accounting for Absorica in-housing and Natroba growth) before giving any credit to further M&A or MOB upside. That’s simply way too cheap.

I don’t want to get any further into Cipher and Moberg, which are not the topic of this piece (happy to talk offline if anyone wants to discuss), but I want to juxtapose these two investments for the purposes of better understanding the concepts that spurred this piece on — viz. asymmetry, capturing right tails through position sizing and holding periods, and margins of safety — and how they all fit together.

Let’s start with Moberg. Despite not working out, this was definitely an asymmetric set up at 19SEK — I believe there was a high probability shot at a multi-bagger, and despite essentially the worst outcome materializing, I’ve lost 40% of my investment. The problem with Moberg, as far as I am concerned, was the nature of its margin of safety — i.e. cash, milestones, and (maybe) the still inchoate European/RoW business. Because the downside protection largely comes from fixed balance sheet items at this stage (we are still a ways out from material European earnings), the margin of safety effectively decreased as the shares appreciated and began pricing in higher US expectations; and of course, because the probability of success in the US could never be 100%, the risk of a material decline increased substantially as shares re-rated into the 30s.

I think there may be interesting and broader insights that emerge from this framing.

Firstly, when you derive your margin of safety from largely fixed assets (e.g. cash balances, net working capital, entitlements, etc.), your margin of safety diminishes as shares appreciate (and the distance between the market cap and your ‘collateral’ grows). As such, holding your investment (i.e. not taking profits) becomes a riskier and riskier proposition as it appreciates (unless, obviously, improved underlying fundamentals have mitigated the downside). This in turns makes it far more difficult to maximize for the right tail in these situations, as one most likely would (and should) not feel comfortable with something akin to Moberg growing into a large percentage of the portfolio.

Contrast this with Cipher.

While I was initially comfortable sizing Cipher up when I first discovered it due to its large pile of cash in relation to the market cap (and high FCF yield), as the business has improved (and my understanding of it has grown), I have come to understand that Cipher’s margin of safety is far more rooted in what I would refer to as ‘qualitative’ attributes - e.g. a strong capital allocator, a durable and lean operating model enabling free cash generation, low competitive pressures, a diversified portfolio, etc. In other words, Cipher’s margin of safety lies in the fact that it is a great business. And the beautiful thing about great businesses is that their qualitative aspects, and therefore margins of safety (subject to overvaluation risk, obviously), tend to get stronger with time. Just look at Cipher. Indeed, despite being up >500% on some of my shares, I truly do not believe hanging on to those shares now is any risker than when I bought them — the company has diversified away from reliance on isotretinoin, added a number of fairly easy growth avenues to capture, and the stock remains at a very undemanding multiple.

But it’s not just that the margin of safety seems wide with Cipher — it is wide. I have stress tested this thing in so many ways and continue to see very little risk in owning this stock. The reason is fairly clear — because the business is conservatively levered, generates a lot of free cash flow, does not need any capital reinvestment to maintain it’s business, and is helmed by a fully aligned and intelligent capital allocator, the ingredients are always in place to right to ship when things do not work out — e.g. even assuming Cipher never markets MOB-015 in Canada, there are surely ample other assets Mull could target to eventually replace those lost prospective cash flows.

These are the reasons why, ultimately, I am comfortable holding such a large position in Cipher and why I have not yet been compelled to sell any of my shares. That, of course, doesn’t mean I won’t lose money from here over the long term (there’s always some risk), but it is definitely a situation where I am able to position myself to maximize the still large right tail whilst being able to sleep well at night.

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Quick note, for anyone interested who has yet to check it out, I was on this week’s episode of the Business Brew and we had a fairly wide ranging chat, including discussion on some of the blog’s open ideas.

As always, happy to chat any time and hope you all had a good weekend.