IPOs In The Pipeline

Some “hot” companies are getting ready to list on the Australian Stock Exchange - namely, Link, McGrah Real Estate and Baby Bunting.

When investing in IPOs it is imperative that you identify the motivations (from the business owners perspective) for doing so. Is it a firm that actually needs money to grow and the managers are retaining a substantial shareholding or is it a private equity flip? I don’t think there’s any question that Link is a great business that have a competitive edge in their market (and a clear strategy for growth going forward) which has helped them sustain healthy margins, good cash flow generation and >90% recurring revenues. However, I question the multiple attached to this business.

The other two companies I won’t make a comment on for various reasons – it would be wise not to infer from this.

The main reason for writing this post is to say that it is with great pleasure that I’m preparing an exciting post about my experience at a small investment firm. Titled “memoirs of an aspiring fund manager” (don’t laugh!) it will detail what I have learnt thus far working in the investment management industry. It is targeted towards younger, relatively inexperienced individuals (such as myself) who might want some insight into the industry and some lessons I’ve learned along the way. Watch this space!

Reporting Season With A Twist

This post is a short summary of a great experience I’ve had over the past few weeks.

This reporting season was very different for me in the sense that I was fortunate enough to get to personally meet various CEO’s & CFO’s from all over Australia and across a wide range of industries.

The structure of the meetings is straightforward, you essentially gather around in a boardroom at a brokerage firm and the company presenting will talk over their results in a closed environment. By this, I mean that it’s generally not recorded and publicised. Followed by the presentation is a Q&A session.

Although I had never heard of some of the firms that spoke, it was a great experience which broadened my understanding of different industries and their key drivers. These drivers are extremely important because they feed into valuation models. My aim was to walk away with a deeper understanding of what exactly were driving these companies and industries more broadly. I believe I achieved this to a satisfactory extent (I’m by no means an expert though).

Some companies and their respective managers which I was lucky enough to meet were: MNF, SDA, PME, BLA, VOC, DWS, RXP, SKI, VTG, RFG and PFL to name a few. 

General Commentary

Global markets are going through a rough ride. Not in my entire investing lifetime have I witnessed such wild vicissitudes in equity markets. While this is probably more of a reflection of my youth rather than anything else, it is still interesting times where our equanimity and rational thought are being tested.

We are experiencing  multifaceted problems in major economies such as China, Greece, America and Australia. Domestically, it is in my view that we have been shielded away from the GFC given our commodity boom. However, it has been apparent for an extended time that the good times are disappearing. The downturn in mining is having a multitudinous effect on our economy. For example, it is having adverse impacts on income, tax revenue and jobs.

Recent studies have shown that wage inflation is going nowhere. Our real incomes, as consumers aren’t appreciating. So what implications may this have? Well, for one, I believe that consumer demand will be weak and this is what I think we are seeing now with the most recent reporting season. A common theme among many companies is that growth in revenue is not transparent. While cost cutting has been a theme for some time, as well as restructuring, we are seeing the implications when these measures are exhausted – margins are contracting. Importers are even more vulnerable to gross margin contraction as the lower $A (predominantly driven by the rapid decline in the demand for Australian commodities) lifts their costs of goods sold.

To overcome this problem, many companies, both domestically and internationally are turning to M&A activity to boost revenues rather than anything else. And boy is the time ripe for that! In this low interest rate environment, companies are definitely taking advantage of cheap credit to help pick up the slack. However, what happens when interest rates begin to rise- especially in the US?

Given the aforementioned, I believe it’s fairly evident that the Australian market is in a tough time for the foreseeable future. Given the lust for yield as a result of the historically low interest rates globally, riskier assets are appreciating while global economic growth is decelerating. Moreover, benefits from the RBA rate cuts are having fewer impacts with each subsequent cut.

I believe the reasons mentioned above are key to the issues Australian companies are facing, namely revenue growth and margin contraction. By extension, I would argue that profitability will be sub-par in at least the near term. Moreover, as I mentioned earlier, the lust for yield have pushed these exact companies to prices which may be unjustifiable. Do you see the spiral effect I’m trying to achieve here? The low interest rate environment is evident of a weak economy; however, this is pushing investors into riskier assets – such as shares. These companies, given the weak economy and lack of consumer demand aren’t delivering. This problem is enhanced by the premium some investors are willing to pay to own a piece of a company which is able to pay dividends. So what’s the outcome? Investors are paying more and more for less and less. Not only that, but they are increasingly becoming vulnerable to stocks de-rating - which has become more apparent with some companies which have come out in the FY15 reporting season. Over the long term, it sometimes pays to arrest our inherent rapacious actions which may do more worse than good.

A prevalent theme of the FY14 reporting season was a lack of EPS growth on a broad level. Interest rates we’re still historically low back then and investors demanded dividends. As a result of the latter overpowering the former, (on a broad scale) payout ratios unambiguously rose at the cost of investing for future growth. As the labour market continues to weaken it will be interesting to see where the growth will come from. I believe technology will no doubt have a big role in this.

Despite the relatively bearish atmosphere i may be depicting, I wholeheartedly believe that the astute manager can still generate outsized returns in this environment. Why? Because if history is any guide, then it is definitely possible. Returns may not be as easy as they were previously, but this is only a guess at best. Unfortunately, i wasn't blessed as a Seer and so i cannot detect what the future holds.

Downgrades left right and centre

High quality Australian businesses have recently been slogged amid profit downgrades. Companies which have flagged downgrades include Seek (ASX: SEK), Flight Centre (ASX: FLT) and others such as Nine Entertainment (ASX: NEC) and Qube Holdings (ASX: QUB).

A recurring theme is that revenue growth has been an issue. They have been expanding bottom lines via cost cutting but this will only go so far. It is worrying to see companies which are not only deeply intertwined with the economy, but also, are of high quality see problems at the top line. Other companies such as IOOF have been dumped by the market amid "rumours" of a whilseblower who told Fairfax Media that IOOF have engaged in activities such as insider trading and front-running.

While some may argue the market has overreacted, it pays to think independently. When companies such as Seek and FLT come out with profit downgrades, this doesn't paint a bright picture for me going into reporting season. I believe more downgrades are imminent given the not before seen shift in the global economy and the repercussions we are seeing.

Companies which can display growth in earnings irrespective of where we are in the economic cycle are ones which should be constantly on the radar. Something that i do to check this at times, is to see how the particular company went during the GFC and compare their performance among peers. This won't work for every company and is much better suited for countries other than Australia (as the GFC had little relative impact on our domestic economy).

Slater and Gordon (ASX: SGH)

I'm posting up a summary of why i bought into SGH a little while back. I hope it is of value to you.

Investment summary


* SGH dominates the domestic market, allowing it to offer pricing models and services which smaller players cannot, creating a valuable competitive advantage
* SGH has identified a similar opportunity for consolidation in the UK and has begun successfully expanding into this market via acquisitions
* SGH has a strong track record of creating shareholder value by acquiring premium international brands that are strategically aligned with its core business – personal injury & consumer law – and highly earnings accretive
* Relatively low leverage with a robust balance sheet and strong operating cash flow generation to offset risk of bankruptcy.


I own SGH because I believe the market is not placing an appropriate value on the quality of the business and its future growth prospects. SGH listed on the ASX in 2007 and has performed very strongly since IPO. Revenue has increased from $60m in FY07 to an expected $540m in FY15, representing an 8-year CAGR of 32%. This growth has been achieved from both strong organic growth and acquisitions.


SGH already dominates the domestic consumer law market boasting a 26% market share. This size, provides SGH with a significant competitive advantage as it gives them access to the most “deal flow”, allowing them to pick-and-choose the deals with the highest expected value. In turn this allows them to offer customers a “no win no fee” pricing model, thereby attracting more customers in a self-fulfilling network effect. Smaller market players cannot offer this arrangement economically. This scale (gained in personal injury [PI]) has also led to a strong brand name which SGH has capitalised on by providing other specialist services.


SGH is drawing upon its success in Australia to enter into the highly fragmented UK market, which is circa 6x the size of the Australian market and where it sees a similar opportunity for consolidation. While growth by acquisition (especially internationally) can be risky SGH have demonstrated a history of successful execution through its acquisition of Russell Jones Walker in 2012, which has continued to remain a market leading player within the personal injury arena. Using their experience integrating businesses successfully, SGH has recently doubled its market share in the UK, from 6 to 12%, with the acquisition of Quindell’s Professional Services Division (PSD).


The PSD acquisition is strategically aligned with SGH’s current competitive edge in the PI arena. Not only have they acquired premium brands and transitioned them prosperously, they have done so in an earnings accretive manner. SGH paid roughly 7x EBITDA for the PSD acquisition, compared with its current multiple of ~15x EBITDA, resulting in a highly earnings accretive acquisition. Ultimately, this allows SGH to gain a better stranglehold of the UK consumer law market via the acquisition on a strong brand with which it can leverage to provide legal services in other areas of the system. When combined with their growing stranglehold of the Australian PI market, this should give rise to abnormal pricing power and thus, a platform to grow earnings at a rate higher than GDP over the medium to long term. I strongly believe that SGH will be successful in consolidating the UK market and achieve a similar market leading position as it has in Australia, thereby achieving the same competitive advantages it enjoys here.


Furthermore this growth by acquisition has not overly strained the balance sheet. Following the latest acquisitions, net debt is expected to be ~$235m as at 30 June 2015, with net debt/EBITDA of approximately 1.9x (June 2015 expected). I believe this level of gearing is entirely sustainable, especially given the strong cash flow generation of the business (free cash flow circa 70% as of net profit).

Please note that this does not constitute personal advice and doesn't take into account your personal finances. Moreover, i have a direct financial interest in the company.

Molopo Energy (ASX: MPO) - the net-net case with an identifed catalyst.

I'll skip the introduction to the company and get straight to the point. Molopo Energy has approx $68 million in cash with little to no liabilities. Comparing this to the market cap of circa $39 million, this makes an interesting, typical Ben Graham type of investment.

The cash burn rate is very, very slow relative to other players within the same industry. The interesting one about this one though is that it has a potentially identified catalyst to unlock value. Two members of the board are from activist backgrounds who together own around 30% of the company. One of the members, who works for a publicly listed company have disclosed their intent to unlock this value for shareholders. The matter went to court but the court ruled against them. Despite this, i still believe the stock may re-rate, maybe not today, or tomorrow, but someday.

If you have read some of my earlier posts, i have mentioned that i don't buy into resource companies due to the nature of their business model. However, given that it is trading at less than liquidation value, the dynamics are different.

Please note that this does not constitute personal advice and that i have a financial interest in the company.

N/A

Placed a bid for Slater and Gordon (ASX:SGH) and hoping Sirtex falls back toward that 15-18 dollar mark. If so, will add more.