Hinkie's "Letter to Shareholders" and the Hubris of Intellect ($FHCO, $BRK)

Summary Bullets:

  • Sam Hinkie, the 76er's GM quit, leaving behind a 13-page resignation letter that reads like a shareholder letter. 

  • As an investor, Philly sports fan and former writer, it's an irritating read for a number of reasons: 1) its the kind of thing that smart people do trying to sound smart, which I call "the hubris of intellect"; 2) it's a totally derivative style, unoriginal and in someone else's voice; and 3) to storm off in a huff b/c he was asked to share power with "a basketball mind" is the kind of ego driven emotional behavior that all the great investors seek to avoid.

  • Hinkie's strategy to lose in order to accumulate assets was quite wild. His abrupt resignation means he'll never have a chance to allocate the bulk of the assets he collected from losing. Therefore we'll never be able to judge the success of his path. 
  • Instead we'll have to judge  him only on his record; they won 47 out of a total of 242 games under his leadership, a 0.24 winning percentage. The cognitive dissonance of his "smart sounding letter" is lost on someone who doesn't follow sports. 

Sam Hinkie, the 76er's GM resigned Wednesday with a 13-page resignation letter that reflects the convergence of my two great passions: Investing and Philly sports. The entire piece reads like a letter to shareholders, opening with a reference to Atul Gawande and an admission by the author that "Reading investor letters has long been one of my [guilty pleasures]."

Still on the first page, he quotes Warren Buffett.

By the second page he's quoting Seth Klarman as well as Charlie Munger's two step process for decision making:

1. First, what are the factors that really govern the interests involved, rationally considered?
2. Second, what are the subconscious influences where the brain at a subconscious level is automatically doing these things—which by and large are useful, but which often malfunctions?"

A Buffett quote / reference shows up again on page 4: "Warren Buffett in the late 80s on this topic: “In any sort of a contest—financial, mental, or physical—it’s an enormous advantage to have opponents who have been taught that it's useless to even try.” Ask who wants to trade for an in-his-prime Kevin Garnett and 30 hands will go up. Ask who planned for it three or four years in advance and Danny Ainge is nearly alone."

Followed by Howard Marks:

"Howard Marks describes this as a necessary condition of great performance: you have to be nonconsensus and right. Both. That means you have to find some way to have a differentiated viewpoint from the masses. And it needs to be right. Anything less won’t work."

Let me remind you, this is the resignation letter of a basketball GM. Red Auerbach is barely mentioned.

On page six he quotes TED-talker Tim Urban ("one of tomorrow's polymaths").

By page 7 he's writing about disruption and quotes Max Planck: “A new scientific truth does not triumph by convincing its opponents and making them see the light, but rather because its opponents eventually die.”

He even throws in the word "zugzwang" somewhere towards the end.

The cognitive dissonance of this letter might be lost on someone who doesn't follow sports but the record shows that over the last three seasons the 76ers have won just 47 games out of a total of 242 played. That's a 0.24 winning percentage. They are dying, not their opponents.

So there's an inherent incongruity here that resolves itself to what I call "the nauseating hubris of intellect". Because even while Sam Hinkie quotes smart people, indicates a practice of and reverence for incredible investors, he built a team that has one of the worst three year records in the history of professional sports.

To his credit, and as Hinkie's letter points out, the team was successful at achieving its plan of losing in order to acquire assets. When Hinkie was named GM, he inherited a bad team with few good options and the goal was to acquire future assets for long term success by losing a lot in the short term, getting high draft picks and drafting good young players with "upside."

So the record doesn't tell the whole story and looking at it alone isn't fair to Hinkie.

But his resignation itself tells another story. Although changes in the executive suite resulted in his having to share power with more traditional basketball minds, his leaving now, near the moment when he'd harvest the results of his three years of tanking, sounds like ego and emotion acting over wisdom. That is distinctly un-Buffett, un-Klarman and un-Marks.

Everyone wants to compare themselves to the greats but when we look in the mirror, unless we have the record to show a comparison, we can't. The best we can do without such a record is humbly ask ourselves what we are doing to pursue and reveal truths, first about ourselves and then about the world around us. "To seek the truth and knowing it give the light" is the one thread that binds all great minds, people and art.

I'm not sure what truth if any Hinkie has revealed in his tenure or his departure except that it's unlikely anyone will try this extreme case of tanking again.

Outside of the "future assets" it remains unclear how well Hinkie did as a talent evaluator - drafting "good young players with upside" - since it takes at least three years to evaluate talent and none of the first round players they've drafted or acquired over the least three years have played for that long or are still on the team. (An example of Hinkie's work is with Michael Carter Williams, drafted in 2013 #11, named Rookie of the Year, and then traded for future draft picks that they will harvest this year).

And although they have successfully acquired draft picks, what is done with the picks, how they are coached, how the practice is implemented, etc. all factors into the equation. Hinkie won't be around to conclude what he started.

If he had any success at all, it's in setting the team up for the future. As he states in the letter, and I include his underlines for emphasis:

"In the upcoming May draft lottery, we have what will likely be the best ever odds to get the #1 overall pick (nearly 30%), a roughly 50/50 chance at a top-2 pick (the highest ever), and a roughly 50/50 chance at two top-5 picks, which would be the best lottery night haul ever. That same bounce of a ping pong ball (almost a flip of a coin) will determine if we have three first round picks this year (unusual) or four (unprecedented). That's this year. Or this quarter, if you will.

If you were to estimate the value of those firsts and the ones to follow, from this point forward we have essentially two NBA teams’ worth of first round pick value plus the third most second round picks in the league."

The whole thing is funny to me almost in the way it would be funny to be a passenger on a jet plane flown by someone who says "I studied from the great pilots, except I never learned how to land."


It's also funny to me in context of yesterday's merger announcement by $FHCO.

It is one of the strangest, surprising-est and most bizarre capital allocation decisions I've ever seen in that it combines a one-product company owned primarily by value investors who are attracted to a balance sheet and cash flow, with Aspen Park Pharmaceuticals, a bio-tech company that owns patents / has rights to some prostate-cancer drugs, new formulations of existing drugs and also has a consumer product "Preboost" that uses a topical anesthetic wipe to alleviate premature ejaculation.

I reckon the pairing makes sense in that it combines an unusual and irrelevant male consumer product with an unusual and irrelevant female consumer product.

I can further imagine the CEO of FHCO being sold on the merger idea simply with the promise that as a combined company, the marketing genius behind Preboost would bring the FC2 to consumers.

I've written about $FHCO in the past and have long thought that its CEO and Chairman OB Parrish has too much of a beloved view of his product, and in an unconsciously patronizing way. As I've learned talking to social workers and other professionals in the sex work community, the FC2 is a joke with likely no consumer market outside of novelties, but even the novelty market at a certain price has an investment thesis (eg $BRK owns Oriental Trading).

Why a product that received FDA approval in 2009 isn't already on the shelves has been a mystery to me for years, particularly if the company fumbles its market lead if FDA re-classifies the device. Parrish told me once - with no irony - of seeing the FC2 on the shelf of a corner store in an upmarket section of San Francisco selling for $15 / pack  (nearly 5x retail price) and the grocer telling him that its used by gay men off label for anal sex.

Yet, he didn't seem to appreciate what that meant about supply / demand and what could happen to sales if only they would get their product on the shelves in a variety of cities with large gay populations.

Needless to say, I should have stopped trusting the CEO, himself sitting on losses, to make wise and sound capital allocation decisions with the belief that I could go along for the ride, which has now taken a very strange and unusual turn.

I read the current move as a hail mary by someone near retirement age and sees this as his best way to turn a weak hand into a potential high return.

When I asked him why he didn't just sell half the company and buy powerball tickets and he laughed. I presume he thinks a bio-tech has greater opportunity for success than a lottery ticket. Time will tell. If there's a lesson in both these stories it's to invest with managers who can fly the plane and also land it.

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