[TOP STORY] Benefiting from delistings

‘Bad companies tend not to be delisted, because no one wants them, so the delistings tend to be good companies with good cash flows’: Keith McLachlan from Integral Asset Management.

SIMON BROWN: I’m chatting now with Keith McLachlan from Integral Asset Management. Keith, I appreciate the early morning time. A trend that’s been frankly going on for a number of years is delistings from the JSE, mostly in the small- and midcap [sectors], although we’ve had some larger ones: I’m thinking Pioneer [Foods] and one or two others. I’m trying to think – how do we make some cash off this? Is there a way to maybe identify some of those smaller stocks and kind of get in ahead? Or is it a bit of a hit and miss?

Read: Another flurry of delistings hits JSE

KEITH McLACHLAN: Morning, Simon. First of all, you are touching on delistings from the JSE. It’s actually a global phenomenon. Stock markets around the world have been shrinking; the bigger [counters] becoming bigger and a lot of the smaller and mid-caps are disappearing out the universe. So it’s not unique to the JSE. It is perhaps aggravated here. But … in terms of profiting from a delisting, there are only really two ways of looking at it.

You can invest after the announcement, in which case it’s a play, it’s almost an implied interest rate [play] where your opportunity cost you’re trying to beat is safe, low-yielding cash versus a slightly risky closing the gap between whatever the share price is and the delisting price, given a slightly uncertain outcome and the timing of funds flowing, [for] which you can create an annualised interest rate there.

Or you can invest before the announcement, trying to identify things – which is very, very hard, we can chat through some of those characteristics – or you know there’s a delisting coming, in which case it’s insider trading and that’s illegal.

SIMON BROWN: That’s illegal. We’re not going down that path. Let’s quickly touch on the former. For example, ARB Holdings offers R8. The market is at R7.70. That gives me 4%. It’s not exciting, but OneLogix offers R3.30. The price is R2.89. That’s a 14% premium. Of course, the OneLogix is not yet inked, and I suppose that’s the difference – it might not happen.

KEITH McLACHLAN: Certainly. So you’re not just looking at the timing. Say, for example, OneLogix’s [delisting] might takes six months or nine months to happen, whereas ARB might take only three months to happen. That creates a different interest rate because you’ve got to annualise that return to arrive at an interest rate you can compare versus interest rates in the market. So that’s the first thing to consider.

The second thing to consider is, for example, ARB Holdings has a large proportion of irrevocables, meaning people who have said they will vote in favour of the scheme, and therefore the odds of it happening are much, much higher relative to OneLogix, which will be put to vote and you’ll see how that turns out. So you’re not just comparing the difference in timing, you’re comparing the difference in event risk. Does it happen or is there a chance it doesn’t happen?

SIMON BROWN: If it doesn’t happen you are left holding the stock. So please make sure you like the stock.

Are there some tell-tale signs around a possible delisting that’s coming? You don’t have any inside information, but maybe you see [at] Mustek, for example David Kan, who’s the founder, suddenly off and increasing his stake. Are there tell-tale signs, or is the market frankly too dynamic, and you’re looking in one direction and it happens somewhere else?

KEITH McLACHLAN: This is an interesting question. It’s always a tricky one to position. So my advice is relatively generic here.

You cannot go wrong holding a portfolio of good companies in good valuations.

Now what happens is bad companies tend not to be delisted, because no one wants them. So the delistings tend to be good companies with good cash flows that have high replacement costs, low valuations. First of all, you can’t go wrong. Even if they’re not delisted, those are great investments to hold. But these tend to be the ones that people shop around for, looking for private equity money to deploy into delistings and the like.

So perhaps one layer deeper, if you very specifically want to look for this, you want to look for one of two things in existence, and assuming it’s a good business, good cashflow and low valuation, that will sit in the share register.

You’re looking at either a large anchor shareholder that is jaded, so they’re tired of being listed and not getting any value from that, or you’re looking at absolutely no anchor shareholders.

So someone can swoop in and offer to all shareholders a reasonable price, and most of them will jump at it. Despite the fact that most institutional shareholders will wax lyrical about being long-term shareholders, if you offer them a 30% higher than share price offer, most of the guys will jump at it because they look really great in terms of their track records in the short term.

So you’ll see it on the share register: an anchor jaded shareholder who’s tired of being listed, who will back the offer, or you’re looking at absolutely no institutional shareholders who will jump at a premium. That, combined with a good business and low valuation, and maybe you are onto something.

SIMON BROWN: Yeah. I like that. It needs to be a good company, it’s needs to be a good valuation so that if it doesn’t get delisted you’re actually comfortable holding it. But that’s quite sneaky. I hadn’t thought of the share register, particularly when there’s no controlling shareholder, as you say. Everyone jumps to that 30%. We all say we are long term and truthfully we are, but if you offer 30% overnight, as a rule folks will take it.

Keith McLachlan from Integral Asset Management, I appreciate the early morning.

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