Posted by: donmihaihai | July 26, 2008

Takeover.

Not Again

Yes, Not Again! That was the reaction I had when seeing the announcement of Cash Offer for Bright World. After a 2 months gap from Midsouth which I sold in the open market recently after share price surged to >95% of the offer price, now I get another one for Bright World. And just like Midsouth, the cash offer for Bright World is another concentrated effort by the majority shareholders to delist Bright World and list it elsewhere where better valuation is possible, except that this time future planning and steps are already lay and shown for Bright World’s minority shareholders to see.

Because of the concentrated effort by majority shareholders, it is very difficult for minority shareholders to fight so that the companies will remain listed here. And what is so good about wining these battles? Beside pride, nothing else. It is like sleeping in the same bed with a wife whose heart is with another man. Don’t dismiss the effort and tactics management will takes for coming back for a second or third time and which will/may affect the business in short to middle term.

Warning!

Incentive tendency is at work, right in those S-shares. The incentive or disincentive is valuation. It is true that almost 100% of S-shares are consider small and since it is listed far away from the action, China, it is very easy to view them as somehow lower qualities which come with lower valuations on average. Once a while they may trade at a higher valuation because of the favourable market but volatility and long period of low valuation can be the norm especially in the early years. The average valuation will slowly but surely move upward for various reasons with most probably being 1) increasing number of S-shares 2) increasing number of S-shares with a bigger capitalisation not due to extreme valuation 3) lead to increasing investors/medias talking note of S-shares due to bigger capitalisation, critical mass and profitability.

This is one of the reasons that I believe buying low valuation S-shares with bright future will do wonder. For bright future, one has to take perhaps as long as > 10 years which mean those companies listing here during bloom time of their industries and will fade away in another 3 to 5 yrs time are excluded. Taking such a long period is not because of buy and hold of value investing but for the average valuation to move to a respectable level, it is going to take years. I don’t know how long but I won’t be surprise that the period is > 10 years. It is an investor heaven for the current period because of long period of low valuation. BUT this create disincentive for the owner/management of these S-shares because of the persistent period of lower valuation. And envy play a part too, why should they be listed in a place where they are not being appreciated especially when their counterparts are enjoying the mass orgies of higher, if not extreme valuation?

Companies like Midsouth and Bright World with very bright futures but not being appreciated are likely to delist leaving those lower quality S-shares with lesser options behind. If this gathers speed, it may become a situation where higher qualities S-shares are delisting faster than lower quality S-shares are coming to list. A self-correcting mechanism of the market will correct this in time due to the semi-efficient market at work but it may be too late especially so when I don’t see anyone talking about Midsouth when the offer come. Bright world cash offer get more attention only because of the premium of almost 100% from the last trade price.

It is a warning but nothing much can be done because while we have a window of opportunity to have those S-shares to list here, we do not have the critical mass and too far away to give them the right kind of incentive. I hope for a good outcome but currently China regulation is working at the opposite direction.

Its work

While luck can play a big part, but with 3 companies(5 if Food Junction and Jaya are included) being offer for privatization on last 2 years out of 33 stocks that I ever purchased in my whole investing journey of 7 years, I think I am at least on the right track. Because the hit rate is about 10%. While I dislike takeover because of the wasted efforts, that is something I cannot control. What I can control is buy cheap and takeover, especially privatization does pointed out that I am not on the right track.

Management buy outs (MBO)

I started out with a stubborn thinking that I must received rich valuation or at least a fair valuation on any takeover situation before I will sell out if not I will fight until the end even though I have no bargain as a super small minority shareholder. It looks correct because why sell away just because they pay a higher price or premium on the last trade price? One must measure the offer price to what suppose the intrinsic value or fair value of the stock. Sell only if I get a better valuation.

But reading 1Q2007 Third Avenue fund shareholder letters written by Martin Whitman where he touch on why he tend to vote in favour of takeover in most of the cases for MBO change my thinking. I think it is right and it matches the incentive, disincentive tendency nicely.

In summary is:

MBO seldom happen at a fair price.

If control persons were unable to buy businesses at prices that represent discounts for them, then buying interest by control persons would dry up.

Willing buyer-willing seller is a much more useful standard than requiring a buyer to pay full value.

Of course I am not managing a fund and I do not buy a stock because someone will pay me a higher price in the future when takeover happens. So I shall disregard this? No as there are second or even more consequences. Just like sleeping with a wife when her heart is with another man, there are many ways where she will try to break away and it usually won’t be good because I will be constantly watching my back or her to prevent bad things happen. Will this produce good and healthy family or good shareholder value? No of course, like a happy couple with many kids, a happy shareholder relationship with management working for both majority and minority shareholders produce better value.

And how interesting, the buying of control interests in Food Junction shows that arbitrage opportunity does exist in partial takeover.

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Responses

  1. Hi,

    One problem I have with S-shares is that it is very hard for S’pore investors to monitor a company’s performance against its competitors. There have been many cases of companies doing doing well, with high growth rates and profit margins, then suddenly being ‘attacked’ by numerous new competitors and seeing their profits crumble: Asia Dekor, Want Want, and more recently Synear come to mind.

    For myself, if I am investing long term based on FA, I will only invest in companies that are market leaders (first, second or third) in their product market share, *and* I can name their competitors (This is for any company, not just China companies). I have recently done an analysis of pfood at http://profithunting.blogspot.com/2008/07/peoples-food.html I think it is undervalued and its profits will rise in the next 1 or years. If you get time, pls visit and let me know what you think!

    Oh, and I think the takeover is still beneficial to you even if it is undervalued. You are still getting a premium to market price, and hopefully you can use the cash to find something *more* undervalued in the market.

    BlackCat

  2. Hi,

    Tried to leave a comment yesterday but couldnt.

    Regarding the S-shares, I think it is difficult for S’pore investors to track the performance of the underlying compaines. There are many examples of companies with high margins and growing profits suddenly ‘attacked’ by new compeditors driving down their profit margins: want want, global tech, and more recently synear come to mind. To guard against this I like to only invest long-term in companies that are leaders in their market segments. I recently did an analysis of Pfood at http://www.profithunting.blogspot.com If you are free, come visit and let me know what you think.

    Abt the takeover, I think you should just take what the market gives you and move on. You are being offered cash (at a premium to market) at a time the market is falling….that must be good right? long term, you should be able to re-deploy the cash elsewhere

    Regards,
    BlackCat

  3. Hi BlackCat,

    Sorry, your comments were marked as spam. Just de-spam them.

    Thanks, I have already decided on my course of action for Bright World.

    For your thoughts.
    Let say you are living in Beijing, are you able to monitor Want Want, Synear or Pfood performances in WHOLE China by going to their retail outlets in Beijing? Of course there will be more scuttlebutt or news locally. To get more insights through running the ground, the amount of time and work is certainly much more than just reading news and financial statements.

    Saying that, and doing the same thing here in Singapore without running the ground, I don’t think we are in a much much less disadvantage as a retail investor compare to a China Chinese.

    My thoughts on sudden “attack” by competitors.
    It is not sudden. The nature of competition says that it WILL happen especially those with BIG FAT MARGINS. It is the question of how fast competitors are coming. What more those companies are not huge and many, especially non state owned are in business for only one to two decades and reached a certain scale only in the last 5 to 10 years. And market leaders? Unlike what we commonly read and know of the west, it is still early days for these companies and the writing is not on the wall yet.

    As for Pfood, I think the chances of increasing profitability for the coming years is pretty high. I do not agree that Pfood is operating in a highly cyclical industry. And due to “happenings” in the pork industry for the past 5 years, there may be structural changes which move toward integrated player or large scale pig firming which favour big and strong players.

  4. Hi,

    Glad to hear you believe Pfood has a good long term future. My biggest worry is competition from Shanghui. The pig disease/shortage is only temporary and I think the market has overpriced this problem. Well anyway, I am confident that as the second biggest pork producer in China, it wont disappear overnight!

    Agree it is the nature of our economy that a company with fat margins will be attacked. I believe that only a company with a) dominant market share and b) only a few smaller rivals, will not suffer from competition, even if they have big fat margins. eg: coke, microsoft (but they may suffer in other ways). Very few companies have this: Unisteel, maybe Keppel, are the only one I can think of on SGX. maybe SP Chemicals has local monopoly for its low value chemical production… Thats it. You can count these sort of companies on your fingers!


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