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Wrapping up Vita Group

Wrapping up Vita Group

Today’s blog will most likely be our final with respect to Vita Group Limited (ASX: VTG). In a portfolio of 20-30 companies, we will make mistakes – and VTG is, in absolute terms, one of our larger ones. Importantly, despite this loss and others The Montgomery Fund has outperformed over the long term. We also maintain a continued focus on where and why we erred.

In that spirit, it seems a worthwhile exercise to document what happened with Vita Group since our last blog post ‘Why we continue to hold Vita Group’ on 15 May 2017.

One of the key parts of this blog was a scenario analysis in which we noted that the probable upside from holding our investment in VTG was greater than the downside potential as expressed below:

“The decline in the EBITDA run rate clearly has a negative impact on the valuation that can be ascribed to the shares of VTG. VTG is still in the process of negotiating a new commission structure with TLS and because of this, a great deal of uncertainty has been incorporated into the current share price (i.e. there is the potential for further declines in the EBITDA run rate to come).

On Wednesday (last), VTG’s share price fell from roughly $2.25 to around $1.50. Factoring in the possibility of very poor outcomes, our valuation in VTG is well in excess of the current share price. Given such a large differential between our estimate of intrinsic value, we are retaining our investment in VTG, however the lower market capitalisation prevents us from acquiring more.”

Of course, upside/downside analysis is not a replacement for a crystal ball. As fund managers, we don’t know the future and can only attempt to structure a portfolio which tilts upside in our favour after reading company announcements, doing deep analysis and speaking to management. Some investments however will inevitably detract from our overall performance as this one clearly did.

Little more than two days after the previous blog post (on 17 May 2017), and arguably inconsistent with both the company’s previous announcements and their communications with us, Vita Group’s problems became much worse with Telstra Corporation (ASX: TLS) changing its remuneration terms.

It was announced commissions for Telstra retail stores were to be cut by 10% from 1 July 2017, with further cuts of 10% in each of FY19 & FY20. These cuts in our view have the potential to decimate VTG’s future profitability and it’s hard to be certain that further negative changes in the firm’s commission structure would not occur.

It is now apparent that Kevin Russell’s appointment to Telstra in April 2016 would produce similar changes to the company’s relationship with its retail network as had occurred at Optus when Mr Russell was there.

Following the announcement in May, we sold out of Vita Group, forming the view that whilst the share price may rebound, it would do so at a premium to the firm’s new estimated value.

Our mistake was “sitting on our hands” believing that Vita Group’s CEO, sales culture and unique franchise arrangement was a competitive advantage and that Telstra would be unlikely to change remuneration structures in such a severe way as to impact a vital sales channel.

A more attentive investor might have sold Vita Group shares much earlier. We made the consequent mistake of holding VTG beyond the point where it might have become evident that the prospects for the Company had either deteriorated or become too opaque to confidently assess.

Mistakes are not pleasing to admit however we believe it’s important to do so. Our blog obviously features many instances where we have been right on calls, but to do this and stay silent on our wrong calls would not meet your expectations of transparency from us.

Even though the weighting of VTG in our funds was relatively minor, we are nevertheless enormously disappointed with the result.

INVEST WITH MONTGOMERY

Chief Executive Officer of Montgomery Investment Management, David has over 30 years of industry experience. David is a deeply knowledgeable and highly experienced financial services executive. Prior to joining Montgomery in 2012, David was CEO and Executive Director of Hunter Hall for 11 years, as well as a Director at JP Morgan in Sydney and London for eight years.

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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34 Comments

  1. “Following the announcement in May, we sold out of Vita Group, forming the view that whilst the share price may rebound, it would do so at a premium to the firm’s new estimated value.”

    Given recent announcements and the currently rally from the lows where you sold do you still believe this to be true?

    The fact you went from seeing this stock as a buy at $5 to a sell at 80 cents is somewhat alarming. To me it shows to be that you see outcomes as certain and not enough as a wide, wide spread of possibilities. It would be awesome if you could do a post on what you think about vita after the most recent licensing agreement with Telstra. I guess from a tax perspective however the sell would’ve worked for you nicely

  2. Justin Carroll
    :

    I don’t think the issue of whether a business has a moat turns on whether the business has one customer or client. It turns on who is dependent on whom.

  3. Patrick Murphy
    :

    Would you say that you have made a mistake by holding on to TPM instead of selling them when they were selling at ~$12 + and are now hovering around the $5.50 mark?
    To me TPM looks like a debt laden company full of promises and hope.

  4. Kudos for admitting your mistake.
    One question – when you say the weighting of VTG was relatively minor, was this when it was purchased, always (including when it was above $5 if owned then) or when it was sold?

  5. I think it’s great that you discuss investments and have the courage to do it publicly making you an easy target for criticism when things don’t go to plan and all the hindsight heros come out to tell you where you went wrong, But if you look over the last 7 years, you haven’t done to much wrong from my numbers and if I had to do it myself as I did in the past I would have much less money and hair from my hindsight observations.

  6. I never liked nor bought the company anyway because TLS were involved. Lie down with dogs, pick up fleas. Enough said.

  7. This should be an important lesson in hubris for the Montgomery business. I think that your understanding of moats is quite shallow or for commercial reasons you are moving a long way from the definitions developed by Morningstar.
    If the strict definitions of an economic moat were used it was obvious that the Vita Group did not have one. I believe that you have made similar mistakes with the classification of other companies within your investing universe.
    I can understand why these classification errors may happen in your Australian portfolios as there are very few Australian companies with strong moats. Consequently this means that there are few Australian companies which are true long term investments. This doesn’t mean that there aren’t Australian companies to own but that these positions will be trading positions in the portfolio caused by short term market pricing errors.
    I think that Montgomery would be more respected for actually declaring that this is the case and indicating whether a position is a long term investment or simply a trading opportunity.

  8. Hi David

    We all make mistakes and the important thing is to learn from them.

    Competitive advantage can be fickle as it’s only valuable while it lasts. When a Business generates exceptional returns from a simple business concept , there is always someone out there that will try and steal your thunder or crimp those exceptional returns. When you look back did VTG really have a “SUSTAINABLE” competitive advantage ? Obviously not and that appears to be where the Montgomery team went wrong .

    Lesson – Competitive advantage is only valuable when it’s sustainable.

    • Thanks Max. And on the subject of “sustainability”, particularly with the pace of technological change, many businesses have to re-engineer themselves over the longer term to thrive.

  9. Thanks for providing an open an honest reflection of the investment. I have always been disappointed in the reluctance of the team to provide insights on investments that were not so successful. In my opinion, these are the best times to learn, to understand what I did not see, and to ensure I am prepared for a similar circumstance in the future.
    I am sure you guys got a lot out of that also.

    • Thank you for your comments Garry and Mick. Even the best investors only do well from 60 per cent of their stock picks over the longer-term. Good risk management processes focus on losing as little as possible on the remainder. As I said, we are enormously disappointed with this outcome.

  10. Informative and refreshing on what went wrong. We learn more about your process from the few bad as opposed to all the winners. Keep up the balanced commentary.

  11. Hi David,

    You write that the price might rebound, but at a premium to its new value. By this do you mean that anything beyond $1.50 is at a premium, or full recovery to the $3+ range is at a premium?

    Thanks in advance,
    Matt

    • Hi Matt, “the firm’s new estimated value” is calculated after analysing the new information detailed in VTG’s ASX announcement dated 17 May 2017, being the 10% cut to commissions at each of 1 July 2017, 1 July 2018 and 1 July 2019.

  12. Never a good idea to invest into an company that is so heavily reliant on one client..

    • Generally I would agree with you Arthur, however there are always exceptions. For example, the Montgomery Global Fund owned Footlocker during the second half of 2016 and saw its share price appreciate by more than 50 per cent in that time. At least 75 per cent of Footlocker’s sales are Nike product.

  13. A lesson i learned from holding on to Paladin hoping it would recover. Rode that sucker into the ground.

    • Thank you Steve. As investors, we need to ascertain when a Company’s business model is coming under pressure from a structural viewpoint; rather than just a cyclical viewpoint. If it is structural, generally its best to exit as early as possible, and that is the mistake we made with VTG.

  14. Dennis Bergmans
    :

    Everyone is a genius with the benefit of hindsight.

    I never liked the company because it was too reliant on one supplier. And that supplier had far more clout than Vita. I figured at some point the agreement terms would be changed but I would never be able to pick that point.

    I had the same view with the myriad of education companies relying on government funding. Surprise! The government funding tap got switched off.

      • Greg McLennan
        :

        Vita group’s reliance on Telstra made me pretty wary. It was all fine until Telstra took a careful glance in Vita’s direction. It reminded me a bit of Seymour Whyte which I thought had an unhealthy reliance on government contracts during the Labor government’s reign prior to the election of Campbell Newman’s LNP Government in QLD.

        I suppose in favourable circumstances a small company can make great progress under the wing of a benevolent dictator but when things change….

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