Were Whitney Tilson's Investments Foolish or Brilliant?

Whitney Tilson has been in the spotlight due to his flip-flopping views on Netflix NFLX.

While Netflix stock kept climbing and passed the $200 mark, Tilson claimed the increasing valuation was absurd. Unfortunately, he could not take the heat and covered his position at its high point. He was unable to ride the stock down to the $75 level, although his initial notion was correct. Finally, he recently announced that he initiated a position in the stock due to its relatively cheap price. Only time will tell if Tilson timed his Netflix trade well, but there are skeptics.

Critics have also noticed that two other positions that Tilson holds are somewhat contradictory. Over 2011, Tilson has held long Microsoft MSFT and sold short Nokia NOK.To qualify this observation Tilson made the right call with Nokia, and depending on when he started his position in Microsoft, he could have gained up to 5% but may have also lost a similar amount. He started talking about Microsoft in late 2010, but never gave details as to when he entered the position.

In February 2011, Microsoft and Nokia jointly announced that they will be partnering together to create mobile products. The agreement outlined a scenario in which Nokia would adopt Windows phones as their flagship product, with Nokia developing hardware and Microsoft developing software. Microsoft's global reach would help with marketing while Nokia's existing content would add value to the Windows phone experience as well.

Considering the value proposition, why would Tilson short Nokia and long Microsoft?

One possibility that comes to mind is that Tilson may have believed that Nokia would not be very successful in selling smart phones, given the vast amount of competitors and lack of existing market share. While this may have been the case with Nokia, Microsoft did not have to do much to add value to its balance sheet. Microsoft would have still developed the Windows mobile software, regardless of a deal with Nokia; very minimal tweaks to the software would have been required for the partnership. So in the end, Microsoft is taking very little risk with almost guaranteed revenues. Nokia, on the other hand, took a large risk in the deal, and if the company was unable to move a lot of units, it would have incurred huge losses.

Tilson's strategy not only realized the imbalance in risk profiles for each company, but also acted as a hedge for a long position in Microsoft. In the event the Windows mobile platform was a complete bust, Microsoft would have incurred large costs without gaining much revenue. Nokia would be one of the first companies to be severely affected by such a failure. Therefore, shorting Nokia to hedge the risk of the Windows mobile platform failing was a good idea.

Taking it a little deeper, why would Tilson purchase Microsoft in the first place? Many people familiar with the technology sector believe that Apple AAPL or other niche technology companies offer better growth prospects.

Tilson favored Microsoft over its competitors because it had continuously increased free cash flow, beat quarterly earnings estimates, ramped up dividend payments, and was still trading at a relatively low price/earnings ratio. Tilson ultimately believed that Microsoft market share would not rapidly decline due to Apple or Google GOOG. In the end, Tilson believed that Microsoft had a fighting chance to grow despite the market's view that it was at its end.

Tilson, like many professional investors, let the numbers talk to him. He looked at the probability of Microsoft failing versus Nokia, and decided that the lopsided risk profiles fit his investment strategy. Many retail investors may think that Tilson was contradictory and perhaps even foolish to pursue this particular strategy. However, that is why they are retail investors and he manages a hedge fund.

Microsoft is currently trading at about $26.60, down almost 4.75% for the year; Nokia is trading at about $6.75, down about 34% for the year.

• Microsoft only has to make minimal alterations to its Windows Mobile platform, meaning that it will have very high margins in the Nokia deal.

• Microsoft does not appear to be slowing down in cash flow growth or EPS growth.

• Apple's mobile phone market share is slowly decreasing, allowing Microsoft better opportunities to grow in that market.

• Nokia is a dying brand name and is losing market share on a yearly basis; its decreasing exposure to mobile phone markets may not be saved by Windows Mobile phone offerings.

• Nokia is relying too heavily on the Windows Mobile platform. Even if it is the largest profit center for Nokia, the Windows Mobile user-base is too small to garner heavy profits right now.

• Nokia's margins have been decreasing, even with the Windows phones being live for a half-year at this point.