Finding the catalysts to unlock value

May 2020 - Joe Bauernfreund

At AVI, we invest in companies that we believe are fundamentally mispriced.

Companies trading below their net asset value (NAV) can be significant opportunities. Our investment team strives to identify these valuation anomalies and focuses on investing when the market price does not reflect the estimated intrinsic value.

A mispriced asset is not necessarily a goldmine. In a previous Insight, we identified some of the red flags that may mean a company is trading below its NAV for good reason. An investment is only going to deliver long term value if the underlying assets are strong, and there are prospects that the discount will narrow.

A key factor we look for in an investment opportunity, therefore, is a catalyst for change. So, what are these catalysts and how do we identify them?

Corporate governance

Concerns over corporate governance can be a significant barrier to company performance, shareholder returns and market value. Issues such as director independence and the treatment of minority shareholders can contribute to a company trading below NAV.

Corporate governance has always been a focus for AVI, but more recently is especially relevant for our AVI Japan Opportunity Trust fund (AJOT). The launch of a new Corporate Governance Code in Japan back in 2015 marked the beginning of profound changes to how companies in the country behave and plan.

As a market known historically for its weakness on standards of corporate governance, this was a welcome change. In the years since, the code has led to a greater awareness of the role of shareholders, and of the need to improve value for those shareholders as well as protect their rights.

We see a huge upside in strong Japanese companies willing to proactively engage in reform. AJOT was launched on the premise of ‘engaged shareholding’, whereby we work constructively with boards, management and shareholders to achieve meaningful change that drives long term value growth.

The closed-end fund space is no different. Our AVI Global Trust (AGT) fund has held a stake in Vietnam Phoenix Fund (VPF) since 2013, when we first invested in DWS Vietnam. This was a fund with a successful track record, but which languished on a discount of 40% as a result of various corporate governance issues. These included high fees, a conflicted board, and an absence of discount control measures. Acquiring an 18% stake, we worked to tackle the issues plaguing the fund, culminating in 2016 with the fund being split into two separate entities: an open ended fund housing the listed assets which would realise investments and return cash to shareholders over 3 months, and a closed-end fund doing the same with the private assets over several years.

A key factor we look for in an investment opportunity is a catalyst for change

Corporate Actions

A firm may have a strong underlying asset-backed business, or robust corporate governance, but still trade below NAV. In some circumstances, actively encouraging a company to take decisive corporate actions, such as a subsidiary buyout or the sale of a portfolio company or subsidiary, can unlock huge value.

This is particularly true when it comes to parent-child subsidiary relationships in Japan. These are structures in which the ‘parent’ owns the majority stake of a listed subsidiary company – the ‘child’, with de facto control over issues such as board appointments, capital allocation and the firm’s strategic outlook.

In this scenario, the company’s minority shareholders have little to no say in decisions being made and their wants and needs are often disregarded. This leaves minority shareholders open to the risk of abuse, and of detrimental decisions being made which are beyond their control. Often the best outcome for shareholders will be in the parent company either buying out the subsidiary or selling it. Both options often come at a huge premium to the prevailing share price of the companies involved.

In recent years, AVI have been involved in a push to encourage Toshiba Corporation to acquire two of its child subsidiaries, Nuflare and Toshiba Plant. Letters and media engagement by shareholders such as ourselves, coupled with ongoing pressure from governments and regulators, acted as the catalyst for the deals to be finalised. The acquisitions were completed at a 46% and 28% premium to each company’s respective share price, unlocking huge upside for shareholders.

Balance Sheet Efficiency

A huge potential area for delivering shareholder value is re-structuring value destructive balance sheets. Companies with excess cash or non-related investment securities are clearly not operating efficiently. Many of our activist campaigns have featured elements of balance sheet restructuring, including our ongoing campaigns with Tokyo Broadcasting System and Teikoku Sen-I.

In the past, we have successfully encouraged companies to conduct share buybacks, raising their share price as a result. The share price of Japanese company C Uyemura rose 41% after we suggested they conduct a buyback to improve the efficiency of their balance sheet.

Value destructive balance sheets can mask extremely strong underlying businesses. This issue is particularly prominent in Japan, with a deeply ingrained cultural tendency to serve stakeholders, preserve jobs and look after pensioners. Japanese companies typically hold large amounts of cash on balance sheets, rather than focusing on rewards for shareholders.

 Find out more about how we unlock long term value in our detailed case studies.