MoneyTalks: Here’s how patience pays off for investors in the ASX small cap space
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MoneyTalks is Stockhead’s regular recap of the ASX stocks, sectors and trends that fund managers and analysts are looking at right now in the ASX small cap space.
Today we hear from Martin Pretty, a director at Equitable Investors.
“If you invest in the top 100 stocks, there’s 100 funds and probably 20 broking analysts covering every stock and everyone’s in the index,” he said.
“How on Earth are you going to do better than the market when there’s that much scrutiny and that much knowledge?”
“I think that’s a much harder game. That’s not the game we’re interested in playing.
“We’re interested in investing in businesses where we see opportunities that aren’t fully recognised by the market yet, which tends to lead you down to small cap, micro-cap and unlisted.
“And to us we’re focusing on investing in businesses rather than listed securities, as in we’re not trading tickers on a screen, we are buying shares in businesses.”
Pretty says Equitable Investors, while staying clear of mineral exploration and drug discovery, is otherwise sector-agnostic.
Yet the fund is looking for value, remembering it’s a business first and there’s no trade-off between growth and value.
“We’re bottom up focused, we look at businesses first rather than starting at macro level and drilling down to businesses that fit in it,” he said.
“I can’t stand that [growth v value debate] because it’s both. Growth is valuable but price you pay is important because it dictates the return you get at the end of the day – whatever your time horizon is.
“So we frame it as, we’re looking for companies that are growing or have strategic value at a fair price.”
Nonetheless, one sector in which Equitable Investor has some shares in is tech and it has held no less than three stocks in as many years that have been the subject of takeover bids.
It’s now been many years since Reckon listed, back in the height of the dot com bubble.
Pretty remembers that period well because he started his career with another dot com IPO – broking advisory house Investorweb.
While Investorweb ended up being acquired by the Commonwealth Bank, Reckon survived in its own right – although it was a fight.
“When the dot com crash came, they crashed back to Earth like everyone else,” he told Stockhead.
“But in the time since then you’ll see there’s been a continuity in the management and board. They are owners of the business and you can see through time that they have relentlessly pursued value creation for themselves and other shareholders.
“They’ve had ups and downs. When we set up this fund they were one of our first investments and they got a takeover offer from MYOB for one of their key businesses.
“The share price went up and we felt good about it but the ACCC dragged its feet and never approved the transaction, so MYOB walked away, the share price went to the doldrums and no analysts were interested for a long time.
“We’ve held it since then on the basis that the business generates solid earnings, they’re growing their subscription business, the business they’re trying to buy is one of the key players in the space, it’s an important piece of that market, it still has value.
“And we’ve seen them do several transactions since then to create more value and their numbers are coming through and the market is showing interest again. There’s analyst coverage again now and it’s been a good story of late.”
In 2021, two other stocks in the ASX small cap space owned by Equitable Investors have received takeover offers – and they aren’t the only ones.
“There’s a surge of takeover activity going through in Australia at the moment,” Pretty says.
“When you’re a corporate and cost of borrowing is cheap [and] you’re looking for growth, you’d be silly not to look for opportunities that’d make sense to you strategically at the right place you can get the funding.
“From a smaller companies’ perspective I think there’s a couple of camps – those that’ve captured imagination and run away with momentum and gone to really high valuations.
“Then you’ve got a bunch of other businesses that have solid bases, have been growing, well capitalised, smart people but didn’t capture that imagination. And if you’re an acquirer you’re going to look at the opportunity, compare their capability and earnings to yours.”
And this played out in relation to Redflex and Empired.
“With Redflex, they had competitors overseas who looked at them and said that’s ridiculous and basically offered double the valuation the market was pricing. The market didn’t want to know, it wasn’t one of the in-vogue stocks,” Pretty says.
“Empired is another growth story we’ve followed for years before we started this fund. Once again it’s consistent, persistent, management team who know what they’re doing and board built around them. They generated strong earnings, improved their balance sheet progressively over time and built a strong position.
“I guess it was almost inevitable for them, if they didn’t get re-rated someone would buy them. And if you look at the history of their space, IT consulting, the valuation at which businesses were bought was much higher than Empired was trading before the bid.
“That’s a theme for me – if these stocks don’t get re-rated, an acquirer will do it for you.”
Pretty says fund managers can have an impact in the ASX small cap space.
“I think patience is an important part of investing versus trading,” he said.
“We actively engage with businesses and try to get to know the management teams and the boards and get a feel for how they’re thinking, what they’re seeing, what we feel when we think of what they’re doing.
“If we can be constructive and help them in some way we’ll do that as well, which is another opportunity because you could be great at your area of expertise; as an entrepreneur or CEO you can know your business inside out, but no one knows everything.
“They may not know capital markets, what investors are looking for in terms of governance and communications. So often there’s opportunities as an investor to help companies actually improve their standing in the market so we quite often get involved in that regard as well.”
When asked to name other companies in the ASX small cap space that his fund owned which deserved more attention, Pretty named MedAdvisor.
MedAdvisor’s core software is a “virtual pharmacist” service that allows customers to organise their medication and scripts via smartphone.
“We’ve been a very patient investor for a number of years,” Pretty says.
“But what they did last year was an acquisition in the US which is a game changer in scale and opportunity and they’re proving that at the moment.
“The market hasn’t rewarded them versus the numbers we expected to see them come through.
“I think they’ve got a real opportunity in America where they’re digitising communications between pharmacies and consumers, they can’t do it in the way they do here.
“I would expect if they don’t get re-rated they’d have to be in the spotlight for an acquisition – probably by an American rather than Australian buyer.”
The views, information, or opinions expressed in the interviews in this article are solely those of the interviewee and do not represent the views of Stockhead.
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