Sunday, 3 June 2012

The Correction (& Persistence) Of Anomalies

During dreary journeys across the market landscape scouring for interesting opportunities, the investor occasionally stumbles upon an oasis. Of extreme anomaly. The sighting is generally a mirage, a ray of false hope; but in some instances, the manifestation is very real and extremely intriguing, especially so when the anomaly manifests across companies operating in the same business.

The anomaly was first highlighted here ('Over-priced anomalies in bear markets'), when discussing One Life Capital Advisors (Bloomberg: OCAP IN). Extreme pricing is generally either an outcome of mass euphoria/fear, or a flock of informed market participant presence. OCAP IN seemed to be in the latter category. The post also highlighted the case of peer, Brescon Corporate Advisors (Bloomberg: BFS IN), as an example of under-appreciation. 

For brevity, the scheme of things as on the date of writing (Dec '11) is reproduced:

Such cases of extreme pricing always pique my interest. The situation seemed too far removed from reality. Diligence corroborated my hunch on OCAP IN's ridiculous pricing, and it corroborated my hunch of under-pricing in the case of BFS IN.

A mid-market focused investment banking, debt restructuring franchise with a reasonably long history of operations and respectable brand value seemed to be completely unloved. The company small size ($3.5 mm market value) and low liquidity were partly the reasons. Competition from investors scouring this market segment is limited and severe anomalies sometimes manifest, as a result.

BFS IN was available for far less than its cash and liquid investments (including equities), even after allowing for diminution in carrying value of these investments. Essentially, market participants were assigning no value to the business, a relatively reasonable operating history; a clear anomaly. 

As sentiment picked up in the first quarter of 2012 on the back of renewed FII inflows, stocks of under-appreciated companies come under the spotlight. BFS IN benefited from this surge in sentiment and currently trades at a market value of c.$7 mm, a 100% gain in a few months. The current market value is equal to its cash and liquid securities. Market participants continue to assign little value to either the business or its franchise, which is reasonably strong in its focus area. The margin-of-safety has since compressed but the example illustrates the minimal force that is sometimes required to effect a meaningful correction in anomalies.

On the other hand, the persistence of over-pricing is another intriguing aspect. OCAP IN continues to enjoy a market value of c.$70 mm - 10x BFS IN's market value - which, given its competitive standing, operational history, franchise value, business size, makes for an Alice in Wonderland situation. Shorting isn't the easiest in India but even if one could, the wait and weight of pain would be excruciating.
The principal risk in unloved companies is (1) questionable numbers/management, (2) the absence of a catalyst that could allow restorative forces to act with rigour. (1) is within the realm of known-unknowns and can be tackled to a reasonable degree. (2) is more sketchy. Sometimes, the catalyst takes so long materialising as to be virtually useless for value emergence. The catalyst in this case was an uptick in sentiment. But insisting on fat discounts to true worth allows leeway for unknown-unknowns that might afflict the company under consideration.

I'm watching this one closely, as I continue on my journey across the market landscape.