The Thinking Behind Druckenmiller's Selling Short IBM

Nov.25.13 | About: International Business (IBM)

After my article Why Stan Druckenmiller Is Wrong On IBM had been published, I continued to think about the most incredible mistake in his statements made on TV. Druckenmiller seems to believe that IBM's free cash flow is "sort of $10 billion run rate", at least he said so. The facts prove him wrong, as you can read here. But he has GAAP on his side and he knows that most people won't fact-check his statement. Many will believe him right away. Yet a smart investor like Druckenmiller almost surely knows better. He knows that the receivables from IBM's financing business are included in the GAAP cash flow statement, but represent investments, not cash outflows. It is money lent to clients, not money spent.

So why did he say what he said? And how does his strategy work?

Druckenmiller first gave a speech, then went on TV. In a rather long interview he talked about IBM, then compared IBM to Amazon (NASDAQ:AMZN) and Google (NASDAQ:GOOG), painting a very simple black and white picture. While everything in IBM goes wrong, Amazon and Google have incredible success in everything they touch. Druckenmiller had prepared a catchy phrase that was almost too catchy even for himself, as he started saying it, then inverted the concept, then switched back to the first version: If you want to be short innovation, you have to be long IBM. (A rather foolhardy statement, speaking of the company that has racked up more U.S. patents than any other company for the 20th straight year!)

Afterwards he was obviously asked about his being on the opposite side of Warren Buffett, who is known for having a multi-billion IBM position. This is just perfect for TV: they can make a football game out of it: Druckenmiller vs. Buffett. Who will win? - Yet it's a silly question and a senseless game. Druckenmiller almost certainly will be short IBM only for a short period of time, while Buffett certainly is long IBM for the long term. If the stock market closed tomorrow for 5 years, Buffett wouldn't care at all, while Druckenmiller would probably panic. Buffett would be happy, if Druckenmiller made money with his short, as lower prices would give Buffett (and IBM) the chance to buy (back) more shares on the cheap. And maybe a few years from now we will find Druckenmiller himself on the long side of the trade. Hence, there is just no contraposition. The two players are playing on different playing fields. But it works, at least for the media. It's a compelling story. (My above mentioned article collected more page views in one day than the three I had published in the same week all together.)

So we probably best see Druckenmiller if we see him like an actor. He does not say what he knows, but what he wants the audience to believe. Doesn't he have any doubt on Google or Amazon? Are these companies 100% perfect? Probably not and probably even Druckenmiller does not think so. Remember, the guy has a long and successful track record. He probably does some good research. Yet he paints the picture in black and white. Everything in IBM is going to be bad soon.

Now we have to understand that his research is not so much about the business he talks about as about the perception the world may have of this business. Like at the theatre, it's the audience's impressions that count, not the facts told. IBM is an extremely unpopular stock on Wall Street, it has lagged terribly in a strong rally, it has had a few bad quarters and the next ones will most likely not be great. In Druckenmiller's drama, IBM plays the role of the hero's opponent that will likely loose. Druckenmiller's job on Friday was to push an open door with his audience. And he did it on Friday, because many traders would be afraid to go into a long weekend with such a bad news stock in their portfolio.

When you meet a salesman in the real world behaving like this, probably you won't trust him. Or if you trusted him and later on understood how his strategy worked, you would regret it. And you would trust him even less, if you discovered that he himself had a position in the trade he was suggesting to you.

Disclosure: I am long IBM. I wrote this article myself, and it expresses my own opinions. I am not receiving compensation for it (other than from Seeking Alpha). I have no business relationship with any company whose stock is mentioned in this article.