Various Net-Net opportunities
Benjamin Graham - the father of value investing mentioned about the opportunities of Net-Net in which companies are selling below their net current realisable asset (realisable net current assets minus liabilities). As it is a mathematically easy formula to follow plus the advent of Bloomberg and computer, it soon become pretty hard to find much decent Net-Net opportunities. In today market, the companies which are still selling at Net-Net usually demonstrate the following characteristics
- loss making and will soon turning into net liabilities
- industry is seen as passe
- look and smell like a fraud
- apocalypse fearing management who is incapable of doing anything with their cash holdings
- majority shareholder/management who is milking the company dry through management compensation
Searching for Net-Net had also become automated and unrewarding. Anyone who had blindly followed the formula in recent years would have a very bad experience. Once a while you would come across an article which uses a Bloomberg screen to create a list of stocks which are selling at Net-Net. While the un-wise would take that as an investment list, most would dismiss the list due to the reasons above.
Variant Perception + Net-Net
While the investment returns from Net-Net had been generally bad, it is also an extremely easy way to get a good investment story if you have a variant perception from the market. A few possible scenario can happen
- the company is in a cyclical industry and the industry is turning around
- the company got out of a loss making business and had redeployed assets into profit generating ones
- it is actually a rose around the sh*ts (that why it look and smell like a fraud)
- there is a change in the management thinking and the cash is deployed as dividend, share repurchase or reinvestment
- litigation, or the cow is dead...
Some of good past examples include
When some of the SGX listed China companies were exposed as fraud, some honest China companies' share prices got hammered as well. Some happened to be in the cyclical industry and was doubly affected. If you had recognized that that some of the companies are actually a rose or the industry is turning around, you would have been handsomely rewarded.
Kingboard Copper Foil was a company which is in Net-Net for years with zero motivation from the majority shareholder and management until some threat of litigation appeared. Swiftly, the shares move beyond their current assets
Midland IC&I had been selling below cash valuation for various period of times. While nothing much happened to the cash (except for mildly unprofitability during an industry downturn), the shares improved when the industry turn moderately better.
While it seems that Net-Net opportunities should be arbitrage away in this era of fast computing, we can continue to see possible Net-Net opportunities in the SGX and HKEX. Since most of these opportunities had smaller market capitalization, they are still very much accessible to the everyday opportunistic investors.
Currently, I am continuing to build up two position in 2 net-net companies, one listed on the SGX and one listed on the HKEX. They are both in the unsexy portion of the investment community.
The SGX listed company can be seen as a company that has an apocalypse fearing management who is incapable of doing anything with their cash holdings. But in recent months, there had been a change in the management thinking. They had closed off their legacy business which had been draining on their profitability. Their subsidiary had done well which had resulted in a significant improvement in their bottomline. As long as they continue to work on improving their current operation, I cannot imagine the investment community to continue to value them at half of their Net-Asset Value.
The HKEX listed had currently exited their business in China and will be focusing on their operation in Hong Kong, Macau and Taiwan. The exit from China allowed them to turn net cash and quickly allowed the company to return to profitability on an operational basis. While their industry continue to be challenging, the company is an old hand at the business and operational metrics are improving. The repurchase and cancellation of the shares continued to be reassuring to investors.