Arohan’s investing life

This of course is not a new revelation. However, many readers and investors do not grasp the amount of risk that may be present in smaller companies. A big part of this risk may be just volatility due to illiquid nature of stock, but there are some other more basic risks that an investor needs to be cognizant of when investing in this asset class

To illustrate the points that I am making in this article, I will take an example of two stocks that the readers of this blog are already familiar with. Both these stocks have been discussed here in the past

Syntax-Brillian (BRLC)

This is a major egg on the blog author’s face. However, the case study on this company is worth reviewing to learn where we went wrong.

The rationale for investing in this company was many fold. Syntax-Brillian makes excellent quality HD LCD tvs (brand name Olevia) and sells it at a value price while maintaining great margins due to its optimized supply chain. The market for LCD TVs is growing and the future of the sector looks bright due to a potential for substantial increase in demand in the US due to forced HD conversion in 2009 as well as increased demand in China due to the upcoming olympics. Both markets where Syntax-Brillian is a significant player. The stock was trading at 10-11 PE when it was purchased and had just finished the year with triple digit revenue increases (YOY) and was on the verge of announcing two large big box retailers in US. So what could go wrong???

Well, plenty did go wrong. I would not dwell on BRLC’s history of missing projections to the street (after all if the stock is undervalued and still showing extremely high growth in business, why worry if the analysts estimates are missed. The stock price has to catch up to the potential, right!). No, the problem with the company was (is) really basic. It is in the execution and financial controls

Anyone who has owned a small, fast growing business, or for that matter worked in such business understands that growth requires working capital. If a company plans to grow (as an example) by 50% next year and sports 3-5% net profit margins, not enough cash is generated today to finance the growth for tomorrow. The shortfall needs to be made up by external financing (working capital)

Syntax-Brillian was constantly in need for financing to support its growth. The situation was made worse by the significant amount of business it did in China, where apparently the payment terms of 120 days is common place. This means that the product sold in China did not actually result in cash inflow until 120 days later. Meanwhile the company still has to pay its employees, its vendors (who are typically on a shorter payment term), etc.

And as the sales grew, the cash flow gap became wider and wider and recently it became so acute that one of the institution (Silverpoint)  funding Syntax-Brillian started the process to rein the company in by tightening the controls and increasing the cost of financing. The company, now it appear, has to review its finances on a weekly basis with its lenders and a lot of business planning discretion now no longer rests with the company executives

Ah, the pitfalls of debt financing!

It is not as if Syntax-Brillian did not try equity financing. Over the last 2 years, the equity holders were diluted numerous times to a total of greater than 50% dilution. A part of the stock price decline IS due to the dilutive effect of incremental equity sales.

In short, the company and the stock has been killed by extreme growth (I say killed, but the company is still solvent, although the future looks difficult)!

Generally a growing company picks a growth rate that is sustainable and can be funded either organically or even externally if the company is able to manage its fundamental ratios. But a steady and manageable growth rate did  not appear to be what the company was after as it raced to gain market share as the olympics and the forced HD conversion in US draw closer

There are only two outcomes that can be positive for a company in this situation. Slow the growth down and steady the ship, or, become a thorn in an incumbents boots so much that one of them choses to acquire the company. Sadly, enough shareholder value has already been destroyed before any of these possibilities can come to fruition

Growth at a reasonable price (GARP) is not enough. What we need is Sustainable Growth at a Reasonable Price (S-GARP)

I have exited this name with substantial losses

WSI Industries (WSCI)

This is a company in the metal service industry that we have discussed a few times in the past on this blog. As was reported earlier, the company had announced a significant increase in future business due to new customer acquisition. Subsequent to that, the company reported its quarterly earnings that bettered the estimates and more importantly, showed that the new customer has already started to become accretive to its earnings. The stock responded appropriately, jumping as high as $11s and finally settling down in the $8 range. This stock was purchased in $4-$5 range so there is a good capital appreciation already on my books. I am holding on to the investment for the time being

The important lesson from this is, when investing in micro/small cap companies, one needs to keep a close eye on the investments. The best rewards come to those who hold long term but it is also necessary to monitor the company’s business performance for signs of weakness and act accordingly

PS: Sorry for the brief unintended hiatus from posting! Sometimes life interrupts without warning! 

 Over the weekend this blog was tagged in a link building meme by our friend at Free From Broke. Apparently the idea is to build on the links in the link tag between the Start and the Stop Copying tags by adding five more links to the list. Hopefully, the five blogs that I add will continue the link tag by adding 5 more blogs to the list and so on and eventually this meme will take over the world and we will be the undisputed authority leaders on Technorati. Ah well, that is the concept anyway!

Regardless of how well this works in practice, it is my chance to introduce to the readers to my personal 5 favorite blogs (which you will notice are not all financial in nature). If a reader has some time and follows the links in this meme, he or she will undoubtedly discover some other great and relevant blogs, and that will be a result worth doing this for

*Start Copying Here*

I have randomly selected 5 of you below to be tagged and I hope that you will similarly publish this post in your blog. You will have to tag 5 other bloggers and just keep adding on to the list. (Do not replace, just keep on adding! Yes we hope it will be a long list!)

It’s real easy!

Tag others and see your Technorati Authority increase exponentially!

The benefits of Viral Linking:
- One of the fastest ways to see your technorati authority explode!
- Increase your Google PageRank fast
- Attract large volume of new traffic to your site
- Build your community
- Make new friends!

The Strategist Notebook ~ Link Addiction ~ Ardour of the Heart ~ When Life Becomes a Book ~ The Malaysian Life ~ Yogatta.com ~ What goes under the sun ~ Roshidan’s Cyber Station ~ Sasha says ~ Arts of Physics ~ And the legend lives ~ My View, My Life ~ A Simple Life ~ Juliana RW ~ Mom Knows Everything ~ Beth & Cory’s Mom ~ A Mind Forever Voyaging~ enjoying the ride ~ Jennifer’s thoughts ~ Mom of 3 Girls ~ Amanda ~ Don’t Make Me Get The Flying Monkeys ~ ExPat Mom ~ Just Jessie ~ Wilson Six ~Krisitn ~ Nuttier Than You ~ Shonnte ~ Summer’s Nook ~ Laura Williams Musings ~ Melissa’s Idea Garden ~ Confessions of an Everyday Housewife ~ Blah Blah Blog ~ Stop the Ride! ~Soap, Blings & Girly Things ~ It’s All for the Best ~ Keeping Feet ~ Junky Love in Freehand ~ Getting Out of Debt ~ Free From Broke ~ Money Matters ~ Arohan’s Investing Life ~ My Investing Blog ~ Finance and Fat ~ Iowahippiechick

~ Money Relations ~ Mixed Metaphor ~ Sustainable Democracy ~ Bloggrrl ~ Moolanomy
*Stop Copying*

Please note that the last 5 links were added by me. If your blog is among the five I added, please continue the link tag

Enjoy!!

There is a brewing opposition to Bank of America’s proposed acquisition of Countrywide

First there was a news that the hedge fund SRM Global Fund with its 5.2% stake in Countrywide is opposing the BAC deal . The feeling in the market at that time was SRM may not be able to find any allies in other shareholders

Then comes the new yesterday that Capital World has acquired a 6.1% stake in Countrywide recently. Although Capital World appears to be a passive investor who may or may not side with SRM, they clearly think that the current price is a good value

Today it is revealed that Legg Mason as requested and received approval to raise its stake in Countrywide upto 25%, and its stake has already been increased upto 15% of the company. Additionally, Bill Miller of Legg Mason in a note to investors indicates that he is not in favor of Countrywide sale at the current prices

With many investors now gearing up to oppose the CFC sale to BAC, expect more buying in the stock and gradual appreciation of the stock price. A likely scenario that eventually plays out may include BAC sweetening its offer for Countrywide by possibly offering more BAC stock in exchange for CFC stock. This is getting interesting and even if buying CFC may not work out as a way of getting BAC cheap as suggested in an earlier article (that is if the sale does not go through. If the sale goes through at the current or higher prices than the strategy works beautifully), all the institutional support that is coming back to Countrywide bodes well for a good return on investment on CFC stock itself

If you are invested in CFC I would recommend to stay put. (Of course, there is always a risk of bankruptcy and that is something that you need to weigh)

Hmm, looks like the credit issue is throwing up a lot of bargains! Sometime ago we wrote that Leucadia recently purchased a sizable stake in Americredit. The word is now Leucadia has boosted its stake in Americredit by a factor of 2 and currently owns 22.4% of Americredit with a group of partners. It individually owns about 20.7% stake in the auto-finance company

The following appears in the recent 8-K filed by Americredit (on Feb 6)

Item 8.01 Other Events. On February 6, 2008, the Board of Directors of AmeriCredit approved the acquisition by Leucadia National Corporation and its affiliates (”Leucadia”) of 20% or more of AmeriCredit’s outstanding voting stock. The effect of this action is to make inapplicable the provisions of the Texas Business Combination Law, which, without the action taken by AmeriCredit’s Board of Directors, would prohibit AmeriCredit and Leucadia from entering into any business combination for a period of three years following Leucadia’s acquisition of 20% or more of the outstanding voting stock of AmeriCredit unless approved by two-thirds of AmeriCredit’s outstanding shares not held by Leucadia. AmeriCredit and Leucadia have discussed the terms of a standstill agreement dealing with matters customarily covered in an agreement with a significant minority shareholder, including but not limited to a limit on Leucadia’s ownership in AmeriCredit to 29.9% of the outstanding shares of AmeriCredit’s common stock for a period of two years. There is no assurance that such standstill agreement will be entered into or if entered into, would necessarily be on the same terms as presently being discussed.

Could this mean further increases in this stake are possible?

This is a strong vote of confidence showing a savvy investor like Leucadia believes that atleast some of the stocks in the credit/finance sector have possibly bottomed out

On this blog we have posited over the last several weeks that the US economy may already have entered a period of recession. There have been many economists taking this view recently. A reader wrote back stating that media is possibly overplaying this, we have not seen two consecutive quarters of economic growth declines and the media sensationalism may have the unintended consequence of affecting consumer behavior and thus indirectly pushing the economy in recession
It is important to note that there are many many respected and credible economists and business/government leaders who do not subscribe to the idea that the economy is or will enter into a recession any time soon

US Treasury Secretary Henry Paulson is one of the economic leaders who believe that there is no recession. He iterated this position at comments made ahead of the G7 meeting in Japan. Apparently the Bank of England also believes that there is no need to be overly aggressive as evidenced by only a quarter point rate cut this week. European Central Bank also appears to be more concerned with inflation risk rather than recession risk. There is a belief that the impact of the credit markets meltdown will be mostly localized to the housing sector, other sectors possibly slowing down but not to the point of reversing growth

I really really hope that these leaders are right and not in denial