Privatizations: Unlocking Private Market Value Discounts

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Includes: AIZ, ALOT, AMTX, DDS, ECTE, FALC, FBRC, GWGH, HNNA, ITUS, JCTCF, PNRG, WINA
by: The Value Pendulum

Summary

Privatizations are key resource conversion events in unlocking private market value discounts, particularly in Asia.

I provide a list of 24 potential U.S.-listed privatization candidates based on insider ownership and recent insider purchases and share buybacks.

Value investors should focus on margin of safety and view privatization potential as the icing on the cake, rather than the cake itself.

I previously wrote about using Mario Gabelli's private market value concept as a tool to discover stocks trading for significantly less what informed buyers in the private market will pay to own similar businesses and assets. Like all other types of valuation discounts such as net-nets and sum-of-the-parts, there is no certainty in one way or another that the gap between market price and intrinsic value will narrow or even close. This is where Marty Whitman's concept of resource conversion events like massive asset redeployments, mergers and acquisitions, liability restructurings, changes of control, spinoffs, and liquidations comes into play as a means of arbitraging between public and private market valuations.

For Asian-listed companies, privatization is one of the most common resource conversion events that investors come across for a couple of reasons. Firstly, a greater proportion of Asian-listed companies tend to be family-owned and tightly controlled, lowering the barriers for insiders to buy over the remaining shares owned by minority shareholders. In contrast, U.S. companies are more likely to have open share registers with top management owning under 5% of their companies' shares outstanding. Secondly, Asian markets are less efficient, at least from the perspective of information availability. In this case, while I can't find any studies to support my view, my personal experience tells me that Asian-listed companies have less analyst coverage and media exposure as compared to their U.S. peers, which implies that Asian insiders have significantly more knowledge of the value of their companies relative to outside, passive, minority shareholders to arbitrage between public and private market valuations. Of course, the same also applies to U.S. companies, since insiders or controlling shareholders would likely have an information edge over minorities in any case. Thirdly, there might be simply a larger number of undervalued stocks in Asia. According to research done by Forager Funds, an Australian asset management company, a mere 6% of both stocks listed on the New York Stock Exchange and the London Stock Exchange with market capitalizations exceeding US$250 million capitalisation) are trading at a discount of 20% or more to their Net Tangible Assets. In comparison, more than a quarter of stocks listed in Hong Kong and Korea meet this criterion.

Identifying Potential Privatization Candidates

The key characteristics of privatization candidates include the following:

  • Controlling shareholders with the intention and financial strength to buy over the remaining shareholders;
  • Stock is undervalued relative to private market value, or on any other valuation metric such as P/NTA relative to peers or history, or simply trading close to 52-week lows;
  • Low trading liquidity with limited or no sell-side analyst coverage;
  • Net cash financial position, which implies company has no pressing need to remain listed to tap the equity markets;
  • Past history of privatization bids or M&A offers;
  • Recent insider purchases (refer to my previous article titled "Seeking U.S. And Hong Kong Low P/B Stocks With Recent Insider Buying" for more insights on insider purchases); and
  • Recent share buybacks (refer to my previous article titled "Seeking The Outsiders Among Companies Doing Share Buybacks Close To 52-Week Lows" for more insights on share buybacks).

Screening For Potential U.S.-listed Privatization Candidates

List of U.S. Stocks With Over 30% Insider Ownership And Recent Insider Buying Above $200,000 Since January 2016

  1. BioPharmX Corp (NYSEMKT:BPMX)
  2. General Finance Corp (NASDAQ:GFN)
  3. Transgenomic Inc (NASDAQ:TBIO)
  4. Sarepta Therapeutics Inc (NASDAQ:SRPT)
  5. K2M Group Holdings Inc (NASDAQ:KTWO)
  6. Patriot National Inc (NYSE:PN)
  7. InspireMD Inc (NYSEMKT:NSPR)
  8. Pros Holdings Inc (PROS)
  9. Sarepta Therapeutics Inc
  10. Trans World Entertainment Corp (NASDAQ:TWMC)

List of U.S. Stocks With Over 30% Insider Ownership And Share Buybacks Of At Least 5% Of Shares Outstanding In The Past Year

  1. ITUS Corp (NASDAQ:ITUS)
  2. Assurant Inc (NYSE:AIZ)
  3. Astro-Med Inc (NASDAQ:ALOT)
  4. Aemetis Inc (NASDAQ:AMTX)
  5. Jewett-Cameron Trading Co Ltd (NASDAQ:JCTCF)
  6. Echo Therapeutics Inc (NASDAQ:ECTE)
  7. Saratoga Investment Corp (NYSE:SAR)
  8. Dillards Inc (NYSE:DDS)
  9. Winmark Corp (NASDAQ:WINA)
  10. FalconStor Software Inc (NASDAQ:FALC)
  11. Hennessy Advisors Inc (NASDAQ:HNNA)
  12. GWG Holdings Inc (NASDAQ:GWGH)
  13. PrimeEnergy Corp (NASDAQ:PNRG)
  14. FBR & Co (NASDAQ:FBRC)

Closing Thoughts

Privatization candidates are attractive to investors, because a catalyst exists for the narrowing of the gap between market price and intrinsic value within a shorter time frame. However, as a value investor, I prefer to focus on undervalued stocks with the widest margin of safety possible, even if there are no catalysts on the horizon such as a potential privatization. It is dangerous for investors to be tempted by the potential of a compressed timeline for value realization via a privatization and compromise on the degree of margin of safety they would normally demand. Instead, value investors should continue to focus on downside protection in the form of a wide margin of safety and view the potential for privatizations as the icing on the cake, rather than the cake itself (the main investment thesis for the stock).

Asia/U.S. Deep-Value Wide-Moat Stocks Premium Research

As a bonus for my subscribers of my premium research service, they will get access to a list of six potential Asian privatization candidates, including: (1) a holding company which has bought back approximately 3.3% of its shares outstanding in the past year and whose interest in another listed entity is worth 1.4 times its current market capitalization; (2) a real estate company trading at 0.7 times P/B with insiders buying 1.1% of its shares outstanding in the past year, in addition to the fact that a previous privatization offer was done at 1.0 times P/B; (3) a logistics company offering 40% upside if it is privatized at valuations in line with comparable M&A transaction multiples.

Note: Subscribers to my Asia/U.S. Deep-Value Wide-Moat Stocks exclusive research service get full access to the list of deep-value & wide moat investment candidates and value traps, including "Magic Formula" stocks, wide moat compounders, hidden champions, high quality businesses, net-nets, net cash stocks, low P/B stocks and sum-of-the-parts discounts.

Disclosure: I/we have no positions in any stocks mentioned, and no plans to initiate any positions within the next 72 hours.

I wrote this article myself, and it expresses my own opinions. I am not receiving compensation for it. I have no business relationship with any company whose stock is mentioned in this article.