We’ve all heard the philosophical quandary, “If a tree falls in the forest, will anyone hear it?” I’d like to pose a more pertinent question, “If a small-cap company has a material press release and no one reads it, will the equity ever re-price?”
Let’s go back two decades; I’m living in my fraternity house and it’s the dawn of widespread online trading, where millions of retail gamblers learned that trading stocks was a whole lot more lucrative than going to Vegas. I used to notice that smaller companies would issue what should have been market moving press releases, but the share price wouldn’t respond. Then, a few weeks later, a Wall Street analyst would change their rating on the stock and you’d have a massive re-valuation of the share price. Mind you, this was a simpler time when people actually respected analysts; even if they only paraphrased press releases—much as they do today. My fraternity brothers and I would spend hours a day scrolling through obscure company press releases instead of going to class. We would debate the merits of what was said, take positions and then call up Wall Street analysts to explain why something that a company felt was important enough to press release, was actually important. In retrospect, it’s funny to think that a bunch of 19-year-olds were able to educate a bunch of lazy 50-year old analysts, but it was the internet bubble and the whole stock market was reinventing itself. In any case, we made a bunch of money doing this—far more than we should have as we were drunk or worse most the of the time.
I bring this up because I see a similar thing happening once again today. At larger companies, the stock price moves before I even realize there has been a press release—the algos are just that fast. The next tier down has thousands of hedge funds dynamically re-pricing equities like its their mission in life. Then, you have smaller companies where the global extinction event in small-cap funds means that there is no longer an analytical cohort following these companies. I have now grown increasingly accustomed to reading an important PR and seeing no immediate reaction in the share price. Then, a quarter or two later, the numbers show up in the financials and the computers trip over themselves to buy shares.
Let me give you an example that is near and dear to my fund’s P & L. I’ve written about Altisource Portfolio Solutions (ASPS – USA) previously. For those of you who are new to this site, Altisource is a default mortgage servicer. As the number of mortgage defaults picks up, so will their cash flow. In fact, all evidence seems to suggest that mortgage defaults are primed to uptick soon, making Altisource a prime beneficiary of this trend. I bring up Altisource because a week ago (October 8 to be precise), Altisource announced that they would close down their Owners.com venture capital business. Owners.com lost $8.1 million in the first half of 2019. Annualize that and run-rate losses are $16.2 million. If you assume the rest of Altisource, which is an asset light service provider, is worth somewhere between ten and fifteen times cash flow (you have to strip out non-cash amortization, so cash flow is more accurate), then by closing down Owners.com, the equity should have re-valued by somewhere between $162 million and $243 million or $10 to $15 a share. Those are huge numbers on a $21 share price. If you look back at my original article on Altisource, my biggest concern was that they’d continue to set money on fire in their VC investments. One of my largest fears has now been assuaged and Altisource should do $100 million of free cash flow on a $330 million market cap with no adjustments needed to see those look-through earnings. So why didn’t the shares rise dramatically last week?
Let’s start with the possibilities. It is possible that some shareholders were genuinely excited about Owners.com. I certainly wasn’t. It’s possible that quants sold because revenue will decline as they close down a money losing business. Most likely, I’m one of the few guys that read the press release. I tend to think it’s that simple. The whole float here is about 4 million shares or $85 million dollars. That’s below the size that most funds can care about. I’m sure there’s some younger version of myself in a dorm room kicking back natty light and buying his 200 shares. However, larger players don’t care how cheap Altisource is, it’s not in their mandate. No one cares that next year should see a lot more cash flow—even before mortgage defaults pick up.
In my mind, this is what continues to create opportunity for guys like me who are willing to read the damn press releases. I bring this all up because I see real opportunity in smaller companies that have been ignored and left for dead for far too long.
With that in mind, I will be attending the LD Micro conference, December 10th-12th, in Los Angeles. I will even be speaking on the evening of the 10th. Given the opportunity to opine on anything I want, in front of over a hundred friends and colleagues, my choice was obvious: “Crazy Shit CEOs Have Lied To Me About.” I promise you it will be entertaining, as I’ve been lied to a lot. After my speech, I’ll be hosting a little reception for friends. If you’d like to attend, please click here. Space is limited, so let me know ASAP. I’ll be there until the beer runs out. If you invest in micro-caps and want to attend the conference, please email Chris Lahiji (chris@LDMicro.com) or David Scher (david@LDMicro.com). More info here: https://www.ldmicro.com/events