Skin in the Game
A primary reason for many floats is for the vendors to realise a return on their investment. But when this is the case, potential shareholders become rightly sceptical about the underlying quality of the business. So how do vendors ease market concerns while still maximising their return?
One way is through escrow arrangements, which locks up the vendors remaining shares until a specified date. At the float, the vendor will typically receive a portion of the raised funds but will retain a sizeable shareholding to assure the market that an investment is worthwhile.
In many ways this arrangement can encourage a false sense of security. You see, the escrow period will typically end upon release of the next annual report. Provided the initial guidance is met (and remember, it’s in the best interests of the vendor and management to set guidance that is achievable) the vendors can then sell down their remaining shares while the price may be supported by the broader market.
Strangely, the market does not question the seller’s motives with the same intensity as at the float, yet the initial question remains – if the seller is motivated to maximise their return, why would they sell their holding? In this instance, the selldown is typically lauded by the market, because rather than “exiting their position,” the move is advertised as “providing liquidity.” While more liquidity is frequently appreciated by investors, the underlying motives must not be overlooked.
Dick Smith (ASX: DSH) is one prime example where the vendor maximised their return while keeping “skin in the game” after the float. Dick Smith was primarily floated as an exit strategy, but the vendor retained a 20 per cent stake in escrow as a sign of faith in the longer term prospects of the business. The escrow period ended upon the release of the 2014 financial results, though the vendor announced it had no intention of selling at the prevailing market price given its confidence in the company’s financial performance. Yet the position was exited in the following month at a price near the initial float price (and well above where the share price is now).
Ben MacNevin is an Analyst with Montgomery Investment Management. To invest with Montgomery domestically and globally, find out more.
This post was contributed by a representative of Montgomery Investment Management Pty Limited (AFSL No. 354564). The principal purpose of this post is to provide factual information and not provide financial product advice. Additionally, the information provided is not intended to provide any recommendation or opinion about any financial product. Any commentary and statements of opinion however may contain general advice only that is prepared without taking into account your personal objectives, financial circumstances or needs. Because of this, before acting on any of the information provided, you should always consider its appropriateness in light of your personal objectives, financial circumstances and needs and should consider seeking independent advice from a financial advisor if necessary before making any decisions. This post specifically excludes personal advice.
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RH
:
In hindsight, it would seem that maintaining ‘skin in the game’ at a relatively tokenistic 20% might have been a strategy to maximise the value of the 80% they sold:
http://www.news.com.au/finance/business/retail/the-dick-smith-disaster-explained-in-five-easy-steps/news-story/b95f243d54f423ced869b8ec77838046
vinay-jigna-soni
:
Hi Ben,
Thanks for your views on DSH last month. With recent share price drop following AGM announcement lat week , it seems considerable margin of safety. Is this stock still in montgomery radar ?