Investing in the unlisted

I’m going to stray off the subject of the Thrifty 30 portfolio today, and describe a trade I couldn’t make in the model portfolio because it doesn’t include unlisted shares. In some ways it felt like a kamikaze trade using a small portion of my own pension fund. But I’m relieved to discover, it probably wasn’t!

A blind valuation challenge for you:

Company X has been profitable since it listed in 2004. It grew strongly until 2009, contracted in 2010 and recovered in 2011 when it earned 22.5% on equity. In the year ending June 2011 earnings per share was just under 8 cents (although it’s a British company it reports in dollars) and book value per share was 34 cents.  It’s indebted, but not hugely. It delisted in 2010…

How much is it worth?

OK, there’s not much to go on but assuming company X is sound, it would be reasonable to value it  at least book value, which is about 22p per share at current exchange rates, and possibly ten times earnings, or about 50p per share. Those are typical benchmarks.

Company X is One Horizon, formerly known as SatCom. It announced its intention to delist just days after I wrote these words almost two years ago:

…my main reason for rejecting SatCom is that I don't know what purpose its listing serves. It's an expense and a distraction and at such low prices, its managers must surely be tempted to buy out the remaining shareholders.

Although there's great potential in the share price (and rising dividend), the huge cost of buying the shares guarantees a paper loss in the short-term, and there's a risk SatCom's long-term will not be played out in the stock market.

The cost I referred to was the spread (27% of the mid price), which meant anyone buying the shares would make an immediate loss and with the company 81% owned by its board and the shares incredibly cheap, I thought it likely the directors would make a predatory bid leaving people who’d bought even at these levels with nothing to gain.

The directors didn’t bid. They just voted the company private and left small shareholders with two options, sell out or accept a life in limbo as a minority shareholder in an unlisted company. As shareholders rushed for the exit, the price fell again, from a level I already considered fantastically cheap.

At that point my contrarian instinct kicked in. People weren’t selling because the company was a bad investment. They were selling for the same reason I couldn’t add SatCom to the Thrifty 30 portfolio: they didn’t invest in unlisted companies.

They were afraid they would be locked in. The company promised to match buyers to sellers, but without a liquid market there might be no buyers.

Where I see a wrinkle, a reason why a company might be miss-priced, I feel compelled to act so, out of curiosity, and after confirming my broker would trade the shares once the company had delisted, I bought a very modest stake at 9p. The company delisted. I put a note on my to do list to check up on how the company is doing every year or so.

A broker, Guy Butler Ltd, does the matching for Horizon. The shares are rarely traded but I’d currently get between 15p and 20p a share for them.

So there’s good news and there’s bad news. I may have doubled my money, but the price I’d get now probably undervalues the company, which I reckon is worth as much as 50p (I can’t be sure about that, the future is cloudy because it’s changing from a satellite communications distributor to a internet communications provider).

Maybe it’s not possible to realise fair value while the shares are unlisted and there is very little interest in the stock. One possibility is to offer to sell the shares periodically at a price of my choosing and see if anybody takes me up.

Or maybe I must wait for an event, a flotation or a takeover. One Horizon pays a dividend and occupies a dormant corner of my portfolio. I never hear from the company and only read its annual report. It’s low maintenance.

You might call it a kamikaze trade, but I felt quite confident about it. Still do. Explicably low prices do that.

While I wouldn’t recommend following my example and diving into delisting companies, the risks are fairly inscrutable, I’m relieved to find there’s another investor experimenting with the same tactic.