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EROS: What’s The Catalyst? Do We Really Need One?

|About: Eros International Plc (EROS)

The short seller attack that brought EROS down to its current price of $1.65 was largely disseminated through social media. I began watching social media for additional news and inevitably stumbled upon the Stocktwits Eros board where there are now about 4700 watchers. I was reluctant to begin watching comments there as I figured it would be unhealthy for a long-term investor. However, I have found it to be a fascinating conduit into the brain of the market. It was once only possible to infer market psychology by watching volatility in price movements. Now, social media allows you to read the market as it thinks out loud. It's been entertaining and also confirming to the inefficiencies in the market and value investing as a discipline. There are three main conclusions I have drawn, and I think any one of the 4700 participants would agree.

  1. The market is emotional and ranges from manic to clinically depressed, and rarely in between
  2. There is a wide interpretation of facts when news hits. This usually results in confusion and fear until the information is properly digested and rationalized.
  3. Most participants, long or short, are in for a quick buck.

Let’s think about EROS within this market psychology framework. If you look at the chart, starting in about 2017, the market volatility associated with the first short seller attack in 2015 abated, and the price fell into a range of a low (depressed) of about $7 and a high (manic) about $15. I think we can assume that all information about the company was known and digested and over multiple years, the market assigned this range of value. Then in early June, we are hit with news of the downgrade, and the short sellers help to add confusion, and the market starts thinking insolvency, dilution, fraud, permanent loss of capital. Now the market is willing to part with this stock to anyone crazy enough to take on the risk for $1.65. What happens when the confusion and fear start to abate again? If there isn’t a liquidity crisis and there isn’t fraud and there isn’t a need for dilution, what else has changed that would keep the stock from going back to a range of $7 and $15? I would argue if anything has changed its been for the better! The EROS NOW platform has grown and is becoming a more significant high margin piece of the business. Anyway, there isn’t much reason for it not to return to the previous range or higher. However, on the message boards there is hand wringing over when it will break $1.80 or $2 or a moon shot $5. What is the catalyst!? I would say time. As more information filters into the market, piece, by piece, the facts will be digested by the broader market and the true value will be properly assigned. It is too stressful to try to guess or time the right bit of information to send the stock soaring.

Investors should be more than happy to wait. A jump back to the previous range means a multiple on invested capital of 4.24x to over 9x from the price of $1.65. Let’s say it takes 5 years. I hear all of the Stocktwits Bulls moan. 5 years? Yes, let’s say it goes nowhere and chops between $1.50 and $1.80 all the while you are being mocked by shorts and your friends that are earning 9% annualized in an index fund. On the last day of the 5th year the market gives the stock an all clear and reverts to between $7 and $15. The CAGR on the investment would range between 33% to 55% annualized. Even if it took 10 years you would have a very respectable return of 15% to 25% annualized. That return puts you in the ranks of Soros and Buffet.

Over the next few months there will be plenty of information provided piecemeal that will slowly assuage the fear that’s in the stock price. There has been a lot of focus on Sarbanes Oxley compliance in the 20F. It’s a check box, but I don’t think that alone is anything huge. Whatever controls they had in place failed for the missed debt payments, although on a net basis it would be positive that the company is meeting the highest standard in SOX. More interesting to me is who owns the company after all that June and July volume. We should get 13Fs in during the first couple of weeks of August and if ownership thresholds have been breached then we may see a 13D or two as well. Then most importantly is the second quarter earnings. As of now we are only clear on the company’s liquidity through March end, before the debt payment issue. If the company maintains its growth trajectory and can show ample liquidity, I believe that will begin to lift the stock. In the meantime, we happily wait.

Disclosure: I am/we are long EROS.

Additional disclosure: opinion not advice