Shareholder composition has to be one most disregarded aspects of researching an investment. Most investors look to see what percentage insiders own, and maybe what percentage institutions own, but it rarely goes any further. I have been thinking about this a lot recently in the context of smaller companies with larger majority shareholders.
The big issue I've been thinking about is what role does shareholder composition play in value realization, and as a cause for a depressed price? I've read some articles on a company I recently posted about Guinness Peat Group. The company is a busted growth company that's in liquidation, the shareholder base seems to be long time scorned holders who are so frustrated they're just selling on news of the liquidation. Some might stick around, but this is a very disgruntled group. This shareholder base could be helping to create the undervalued situation.
An example on the other end of the spectrum is a company like George Risk. George Risk is small with a $30m market cap. The founder Ken Risk owns 58% of the company leaving $12.6m as the available float. The company is cheap with $23m in net cash and on track to earn $2m this year. A simple valuation of 10x * $2m plus $23m equals $43m as a reasonably conservative value for the company. The company's profits have been stable, but this isn't a growth company by any measure, it's a sleepy Nebraska company trading close to net cash and securities.
So who are the shareholders of a company like George Risk? The smaller float effectively locks out bigger funds and even medium size funds. But a lot of funds won't invest in a company where after buying a sizable stake they can't affect change, and Ken Risk has a tight grasp on George Risk eliminating fund buying. That leaves the shareholder base to smaller individual investors, and mostly value investors who like the cash story, and like the fact that there's about a 50% upside from here. The company also used to be a net-net which means we have some of the deeper value Graham investors holding on as well (yours truly).
What's the problem with this? I think the problem is value investors are disciplined buyers, so they're not going to pay $40m for a company worth $43m, that's left to readers of Barrons. This means if the company trades close to NCAV there will probably be a lot of buying activity, but as the price gradually rises buyers dry up. The same thing could happen as the stock gets close to fair value, the value investor base sees fairly priced shares and begins to sell driving the price back down.
I don't know if this is a real phenomena, but it intuitively seems so. Some net-net's languish forever, eventually net-net investors give up, or management changes direction which forces deep value investors out. A great example of this would be Audiovoxx, a perennial net-net that spent their excess cash on an acquisition. A lot of value investors jumped ship when Audiovoxx transformed, but the acquisition was good, and the company generated some growth which propelled the share price higher. This isn't to say that an acquisition is the way to a high share price, but the acquisition seemed to change the shareholder base from value investors to investors looking for growth.
I tend to invest and write about companies that have large majority shareholders, and attract value investors, companies such as Micropac, OPT Sciences, and Solitron Devices (1,2,3,4). I'm wondering aloud if part of the undervaluation is that we value investors are our own worst enemies, we are keeping the price low, and if the price rises to close to intrinsic value herd selling begins which drives the price back down.
What's the solution? I think in some of these cases the solution to the market valuation/intrinsic valuation gap needs to come from the company itself. If the shareholder base isn't going to drive the price higher the company needs to be the catalyst. This could mean a tender for shares, or a dividend, or even going private at a fair value.
I don't really have any answers, this post is more of a jumping off point for a discussion then anything else. I'd love to hear confirming or contrary opinions, leave them in the comments.
Talk to Nate
Disclosure: Long all stocks mentioned in this post except Audiovoxx.