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Why I don’t (often) invest in turnarounds

Keith McLachlan lists the ‘death list’ of companies in turnarounds.

Analyst: Mr CEO, how is the turnaround going?

CEO: Well, Mr Analyst, it is a complete disaster and really unlikely to work out, but I’m going to be positive about things because I have a monthly paycheque (and perhaps even an annual bonus) to pick up for however long I can keep the lights on. Oh, I also have lots of share options, so I suppose I’ll say all sorts of positive things to everyone to try to buoy the share price a bit!

How often have you heard the above example’s CEO response to what is obviously a turnaround story in the stock market?

Not often, I suspect.

Neither have I.

There are only three types of turnarounds: those that succeed, those that meander along for years and those that ultimately fail. In my experience, most turnarounds (especially in the small cap space) fall into the latter two categories.

Yet, I have never met a CEO or management team that was not optimistic about its turnaround.

Hence, the first reason I do not (often) invest in turnarounds: you cannot rely much on management’s judgement, answers or guidance.

That means that you are investing mostly blindly into a company, which is really just akin to gambling.

Then there is the second major reason: funding….

Turnarounds tend to occur in the small cap space where the balance sheets are brittle, cash is low to negative and access to more is scarce. This creates a smaller margin for error in the turnaround, which ultimately means the odds are stacked (even more) against the company ever turning around.

This can lead to a quick, sticky end for the turnaround, or, even worse, to rounds of rights issues and investors throwing good money after bad.

Remaining flexible in the markets is central to survival, but on a balance of probabilities I think you can understand why I tend to avoid turnarounds. This is especially true in the small cap space.

Far from listing where to make money, let me give you the ‘death list’ of turnarounds I think are unlikely to work: These turnarounds that will probably meander on (with potential rounds of rights issues) for years and/or even fail outright:

  • Chemical Specialities – commodity business in a depressed market without any real scale.
  • Digicore – no real competitive advantage and some legacy issues in an increasingly overtraded telematics market.
  • Gijima – Loss of reputation and trickle out of key skills in a highly competitive ICT market snowballing its decline.
  • RBA – Playing in the worst part of the housing market (where the banks are the gatekeepers with mortgage approvals) with no real competitive advantage nor stable board or management.
  • Metmar – Commodities trading is getting tough, commodity prices (in real terms) are getting cheaper and Metmar is a small, niche player in a large, beaten up market.
  • Alert Steel – No real competitive advantage in an increasingly overtraded market and management have already bailed.
  • Blue Financial Services – Marginal player in a tightening market with limited funding.
  • Esor – Has sold its competitive advantage (geotechnical) and is currently playing in overtraded construction markets where it has no real track record and competitive advantage.
  • Ububele – No one wins when in the middle of a tough trading period, contracting market and growing loss, management/shareholder power struggles are happening.

The above are just my personal views on certain stocks and they all could quite easily turn out to be wrong. In fact, as I like having great options to invest in on the JSE, I actually hope I am wrong and all of them turnaround into great companies!

That said, I remain sceptical on their prospects and negative on the odds of success. Sometimes, the cheapest shares often turn out to be the most expensive.

This article was first published on here and republished with permission.



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