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Monthly Archives: December 2015

Despite having a notional check list for small caps, I’ve not been very careful with checking it formally. It’s also a good time for a review as my small cap investment style is maturing.

Picture of earthquake survival checklist

Earthquake survival checklist (credit: David Pursehouse on Flickr)

Owner business

As a replacement for the vague “useful business”, I’ll now try to answer the question: “would I like to own, and possibly run, this business as a private company?” However preposterous for a pint-size armchair investor, the idea is that it’s a business I must be interested in and understand enough, and would be happy to be stuck in (swapping CEO roles or even a majority stake in a private business is considerably illiquid compared to flipping listed stocks). This should eliminate a whole class of scams, and encompass classic criteria like “do not invest in things you don’t understand” or “invest like a businessman”. Besides, if one likes a business it’s much easier to weather price weakness, as one can emotionally compensate for (potential) financial failure with satisfaction from higher purpose (within reason).

Takeover potential

I’ve realised that since starting the portfolio many of my small cap exits are companies being taken over by larger groups. This is a pretty nice way to manage small cap exits: no transaction costs, usually a price premium, and no decision to take. And it makes a good sanity check new investment, as a company must be in some shape to be worth taking over.

The wallet test

As a simplified version of the executive character test, I have to ask myself “would I lend my wallet to the CEO for safekeeping?”, trying to guess that from hints in CEO interviews, reading reporting narratives between the lines, or interviews by trusted third-parties. (Idea first seen on the Value and Opportunity blog.)

Access to bank lending

This is about finding out whether a conservative banker would lend to the candidate business. This implies a solid balance sheet and somewhat predictable cash flow. It can be inferred from regulatory reporting on credit lines or covenant updates, or guessed from the balance sheet and business model.

Minimum (expected) profitability

Is this business making at least £1 million (or equivalent) profits annually, or, for recovery situations, can it be expected to reach that within the next 3 years? This takes out things that are too small to be listed, or too far away from break-even. Most story stocks (notoriously disastrous as a class) should drop out here.

The pass rate should be at least 4 out of 5.

In the spirit of the obliquity principle there’s no price or valuation test (other than that implied in the takeover test). Looking at the price too closely is probably counter-productive — I’d expect buying blind based on the above checklist should already give appreciable outperformance compared to small caps as a whole. And in any case I can’t help doing it, which is not incompatible with passing the check list, which is just a minimum standard.

A review of the existing Obliquity London Stamps portfolio holdings is now due.

Hubris

Here is a belated report on (breaking my rule on writing before trading here) for the sale of Tungsten in London Stamps.

Tungsten is an invoicing network that processes supplier invoices for blue chip companies. The processing network is barely break-even and the business model was to make money on value added services, notably invoice discounting (factoring). It’s a fair idea, and goes well with the theme of banking disintermediation which I think will be relevant for some years to come. The problem here was that the approach was full of hubris, which fell flat so far.

The company has now re-framed its ambitions and management: same business model, less hubris. Perhaps not the time to sell, but it’s still materially loss making, and the market hostile. Break even is probably at least two years away, with probably a fundraising or two in the pipeline, so more one for the watchlist, to revisit in 2017, maybe. The market will forget having been burnt, but in the next few years the memory will probably cap the upside. Basically I think it’s highly likely to get cheaper before it gets better, and that some years away.

I probably shouldn’t have invested in hubris, though my rationale was that they only needed to achieve 20% of what they promised to justify their valuation.

But hubris is costly. For instance, reading between the lines of the latest update one guesses they structured the deal with their financing partner so that it paid off above high volume thresholds, so modest but real factoring volume produces zero income…

Gadgets

The proceeds were reinvested in Toumaz, doubling down an existing position back to median weight. I’m still confident the new health products have a chance of success. Liking the product range, I’m happy to give it a chance longer term.

Losing the bulk

Interbulk, the dry bulk business will soon leave the portfolio as the company is being taken over. This was a bet on their market turning from cyclical lows. The company was heavily indebted but with cash flow just enough to fund the cost, and backed by large logistics company who are the controlling shareholders who could support it through bad times, it did not seem too likely to go bankrupt.

Obviously someone else will get the full upside (if any), but as a 30% profit above cost, and a large premium on the recent share price, I can’t complain. The risk the controlling shareholders would not be nice to the minority was also a potential issue.

I think the latest Super Mario move is genius, again, notwithstanding the apparently negative trader reaction.

Not only does a subtle move with tricks that have a potential real effect is probably the best to do domestically for the eurozone (balancing monetary firing power and political capital), but it avoids too strong a move being equivalent to a monetary tightening in the dollar zone, which would make it harder for the Fed to finally do a token rate increase — which is long overdue, if only for signalling purposes and to take that¬† uncertainty out of the system.

Super Mario and star CGI

Super Mario at work (credit: phobus on Flickr)

What are we going to do when he’s gone?

Doubling down some more on Ascent (London Stamps)

Ascent Resources is a seemingly perpetually delayed natural gas project in Slovenia that I’ve added some more to, at 0.9p, a price slightly below the latest fundraise of 1p per consolidated share (1:20 on December 1). The idea here is that most of their potential investors either rejected the project earlier, or got burnt by previous delays and price falls, hence a paucity of buyers facing capitulating sellers. My guess is that the chance of success is higher than that implied by the depressed price, indeed it seems closer to success that at any time in the past when it was considerably more expensive. The main risks seem terminal failure and dilution from the effectively controlling stakeholder, Henderson, who though seem generally above board.

The weight is below my standard small cap entry size but the committed capital (acquisition cost) is a bit high at 2.5 times the standard size, indicating this should probably the last iteration of doubling down, however lower the price goes.

Booze is coming back

In Obliquity London, Diageo has replaced SAB Miller, previously sold due to a takeover. It looks neither very expensive nor cheap — and will probably fall on any profit warning — but I thought I lacked some booze exposure and there’s not much else in the larger cap segment listed in London.