The Liquidity Surprise!
Freelancer shares (not owned by Montgomery) entered a trading halt last week, pending an announcement. While we were aware of the reason for the halt, not all market participants were, so we were unable to discuss this issue with you at the time.
Now that the trading halt has been lifted we can inform you that institutional investors were notified the company was raising $10 million in an institutional placement. “Proceeds from the raising will be used to take advantage of near term growth opportunities including, but not limited to, potential bolt-on acquisitions and acceleration of organic growth, and for general corporate purposes.”
That all sounded pretty promising, remembering the company has recently become operating cash flow positive and reported a 41 per cent increase in net revenue in the first half of 2015 (December year end), and one would expect that major shareholders are excited by the additional value that will be created by these near term growth opportunities, which include potential bolt-on acquisitions.
So it may come as a surprise to some that concurrent with the capital raising is a vendor selldown of $35 million. “Concurrent with the Placement, Startive Holdings Limited [a company associated with venture capital investor Simon Clausen] will sell down approximately 16.4 m Securities at A$1.40 per Security and Matt Barrie will also sell down approximately 8.6m Securities at A$1.40 per Security.” According to the last annual report, Startive owned approximately 167.9 million shares and Matt Barrie owned 200.4 million shares, collectively 84.4 per cent of the company.
So the sell down represents a small change of 6.7 per cent of the holdings declared by the vendors in the annual report. Neverthless it is good practice for investors to question and analyse how relevant or required a capital raising is when it is accompanied by a much larger sell down by vendors.
Postscript: In the subsequent completion announcement, Freelancer.com Matt Barrie said, “I am thrilled that Freelancer is continuing to attract high quality institutions to its register. As we continue to rapidly grow the Company, it is important that all shareholders benefit from increased market liquidity and a broadened share register.”
Simon Clausen said; “ I am happy to support the company’s needs to increase market liquidity…”
Investors however should not allow themselves to be distracted by these statements. Liquidity has nothing to do with business quality or value and neither does attracting institutions to the register. Indeed liquidity can be a curse.
It should be seen as somewhat perverse that liquidity does affect market valuations. Market participants tend to be willing to pay a premium for liquidity. In the case of two otherwise identical stocks, the one with the better trading liquidity tends to command a price premium over the less liquid stock. A stock that is easier to trade in and out of would be awarded a higher multiple than the less liquid alternative. But this is folly and a dangerous distraction to the investor.
To help understand the way stock markets work, Warren Buffett used his 2014 annual newsletter to tell the story of a farm he has owned since 1986. Unless you are a short-term trader, in other words a gambler, Buffett believes you should treat your share portfolio in exactly the same way as you would your real estate investments.
“Those people who can sit quietly for decades when they own a farm or apartment too often become frenetic when they are exposed to a string of stock quotations,” Buffett said. “For these investors, liquidity is transferred from the unqualified benefit it should be, to a curse.” He argues that the goal of the ordinary investor should not be to pick winners: they should simply hold a diversified portfolio and stick with it.
Buffett compared the fluctuations in the share market as akin to an erratic neighbour leaning over the fence screaming out offers for his land every day.
“Imagine a moody fellow with a farm bordering on my property who yelled out a price every day at which he would either buy my farm or sell me his – and those prices varied widely over short periods of time depending on his mental state. If his bid today was ridiculously low, I could buy his farm … if it was ridiculously high I could either sell to him or just go on farming.”
Let’s translate that to our local market. Let’s say you owned a blue chip share XYZ Limited that was selling at $40. The company is highly profitable, paying increasing dividends, is well managed, and is a market leader. Suddenly, due to the possibility of war in Ukraine, Wall Street tumbles, traders all around the world panic and sell, and our market drops 3 per cent. Of course, shares in XYZ will fall too, and you may wake up to find your $40 share is now trading at $35.
As far as XYZ is concerned, nothing has changed. The business is as strong as ever, and 99.5 per cent of investors are happy to sit tight and enjoy the growing income stream. Only a desperate few panic and sell and take a loss, just because the market in general reacted to events that happened thousands of miles away.
No investment offers the growth potential, ease of ownership, or tax concessions of shares. Buffett’s phrase ‘the curse of liquidity’ sums up markets perfectly. Every investment decision you make will have advantages and disadvantages. The downside of liquidity is that you can be tempted to sell just because you can.
Liquidity has nothing to do with business quality or value, so don’t be distracted by it, nor by statements about liquidity from those who should know better.
Roger Montgomery is the founder and Chief Investment Officer of Montgomery Investment Management. To invest with Montgomery domestically and globally, find out more.
Roger Montgomery is the Founder and Chairman of Montgomery Investment Management. Roger has over three decades of experience in funds management and related activities, including equities analysis, equity and derivatives strategy, trading and stockbroking. Prior to establishing Montgomery, Roger held positions at Ord Minnett Jardine Fleming, BT (Australia) Limited and Merrill Lynch.
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.
Patrick Poke
:
Thanks for the insight Roger. Your postscript reminds me of a quote which hangs next to my computer (and which you’re no doubt familiar with):
“The true investor scarcely ever is forced to sell his shares, and at all other times he is free to disregard the current price quotation. He need pay attention to it and act upon it only to the extent that it suits his book, and no more. Thus the investor who permits himself to be stampeded or unduly worried by unjustified market declines in his holdings is perversely transforming his basic advantage into a basic disadvantage. That man would be better off if his stocks had no market quotation at all, for he would then be spared the mental anguish caused him by other persons’ mistakes of judgement.” – Benjamin Graham
Roger Montgomery
:
Well done Patrick. A timely reminder.