14Sep 2015

WHEN A TAKEOVER PREMIUM IS NOT ENOUGH PART TWO

Those of you that know me initially from Twitter as @conkers3, will be well aware of my preference for buying undervalued contrarian stocks that have the potential catalyst of a turnaround. Of course this only forms part of the multi-faceted strategies within my whole portfolio.

The testing thing about buying turnaround stocks is that without strategic and proactive specialists at Board level companies can languish at multi year lows for many years. Therefore selection of such stocks requires extensive research. Not something that all investors have the time or inclination to do.

Therefore it is extremely frustrating when a company that you have researched thoroughly and purchased as a turnaround contrarian stock, gets “taken under” for a low ball acquisition price. Before we as deep value investors can be fully rewarded for our due diligence and taking of additional risk.

When concluding my recent “When a takeover premium is not enough: Part one blog, I mentioned that a fourth “take under” of a stock in my portfolio could be underway.  In this blog I will explain why I am once again facing the prospect of another stock exiting my portfolio at a take under valuation.

Technology stock INNOVATION Group (LSE: TIG), I first purchased in February 2013, for its Claims process technology supplier niche to the Insurance industry and for its conservative measure approach to growth. I say the latter because the purchase was made after much research and due diligence. At the time, there was a cacophony of noise and bullish sentiment from many Investment analysts and many respected Fund Managers who stipulated that Rob Terry’s QUINDELL (LSE/AIM: QPP) was the best way to play the UK listed outsourced insurance technology sector.

I questioned their logic because through thorough research, I had discovered that INNOVATION had been founded by Rob Terry in 1998 and that under his stewardship as CEO, he had taken them in their formative years on an acquisition spree where they acquired twenty five companies in five years. All this before questions were asked about the accuracy of the company’s accounting practices. Once these doubts grew INNOVATION’s share price began to decline and then this decline accelerated. With INNOVATION’s share price eventually falling by 98% and Rob Terry being forced out the company in 2003.

This was enough for me to choose INNOVATION over QUINDELL. The former had taken over a decade to recover from its accounting scandal, during which time subsequent post-2003 Boards had learnt hard lessons, amongst other things that rapid buy and build strategies were not the only way to ensure growth.

I traded in and out INNOVATION shares over the next two years. During which time QUINDELL share price sprinted like Usain Bolt, whilst INNOVATION shares moved more like tortoise. In May 2013 and on other occasions, I raised my concerns about QUINDELL’s rapid buy and build strategy on TWITTER. On one occasion I thought QUINDELL could even be interested in buying INNOVATION.

There is a famous Anonymous quote that says “A lie can travel half way around the world while the truth is putting on its shoes.” That was not the case, however with QUINDELL, whose share price soared by more 600% at one stage. All that changed once Gotham Research released their now infamous scathing appraisal of QUINDELL’s accounting practices and disclosure of their short position against the group. Once again as with INNOVATION before it, QUINIDELL’s share price cratered and in the ongoing melee Rob Terry left the company. Eventually the FCA began their investigations into QUINDELL’s accounting practices and more recently the investigation was taken on by the Serious Fraud Office.

Anyway that is the background to this potential “take under” of INNOVATION, which by the way only re-entered my portfolio for 32p per share on the 1ST July 2015. This after analysing their May 2015 Half Year results and reading a month later that INNOVATION had secured a £46M Software contract with a Tier One UK Insurer.  Making this their largest ever software win!!

My assessment of potential growth and the possible undervaluation of INNOVATION was further enhanced when Panmure Gordon’s Technology analyst George O’Connor, a month later said of INNOVATION “‘we think that the company will split in two before too long SOTP valuation 52p’

For George O’Connor and more importantly all current investors in INNOVATION, that estimated sum of the parts valuation of 52p may never be realised within their portfolios. This is because on Friday 28th August 2015 the Board of INNOVATION confirmed that it is in advanced discussions with The Carlyle Group (US : CG), at 40 pence per share in cash, which may or may not lead to an offer being made for the Company.

Valued at more than $7 Billion, CARLYLE are one of the largest alternative investment firms in the world and are very shrewd Private Equity investors. Back in April 2015 they very swiftly purchased Nationwide Accident Repair Services PLC for £1.00p per share less than a month after QUINDELL had sold their 25% stake in the company for 65p. Therefore their near £500M pursuit of INNOVATION could be very serious indeed. After all telematics and insurance claims technology is a fast growing niche. Is CARLYLE showing intent on accelerating their growth strategy into the Insurance Technology Outsourcing niche?

Extra-ordinarily for my portfolio it now appears that I will be inflicted with my fourth “take under”. My intentions after repurchasing INNOVATION in July, had been to ride their forthcoming growth curve until they had grown out of the shadow of QUINDELL.

INNOVATION are currently priced at 38.75p giving them a £473M Market Cap. It is still early days and anything could happen, however after all the research and time I have taken to find INNOVATION and to add them, into my portfolio, No amount of takeover premium will be enough!!

Due to takeover rules, all investors in INNOVATION will find out by September 25th 2015 if CARLYLE are to make a firm offer.

I will make an update to this blog if INNOVATION does exit my portfolio.

See you all soon.

CONKERS QUOTE OF THE DAY

“If you buy a dollar bill for sixty cents, it’s riskier than if you buy a dollar bill for forty cents, but the expectation of reward is greater of reward is greater in the latter case. The greater potential for reward in the value of a portfolio, the less risk there is.”

WARREN BUFFETT philanthropist, business magnate, investor and recognised as the most successful investor of the 20th century.



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