Horizon Kinetics Case Study on Finova Capital LiquidationVW Staff
Horizon Kinetics September letter below
This month’s commentary concludes our series on predictive attributes with a discussion of liquidations. These are an extremely interesting type of investment, but they are incredibly rare.
Defining the Asset Class
A liquidation occurs when a company’s operations are brought to an end, and the assets of the company are redistributed; this may be the result of bankruptcy proceedings, but is not necessarily so. Generally, liquidations trade at a discount to their liquidation value for a host of reasons. One is simply the nature of the equity yield curve. At the end of a liquidation, the object is to have collected the maximum amount of cash. The security should then be worthless, regardless of how long it takes to liquidate. However, the pace of liquidations—and therefore the shape and length (in time) of the return curve—is unknowable. The process generally depends on either selling assets or collecting revenue under a license or royalty agreement, and then making distributions to shareholders. However, the rate of revenue collection can change for many reasons, and the inability to predict that rate generally means that a liquidation trades at a significant discount to its liquidation value.
There is another reason liquidations trade at a discount to their liquidation value. The requirements of generally accepted accounting principles (GAAP) are such that, in some cases, the auditors must use liquidation accounting. This requires auditors to calculate the equivalent of a unit value for the company in liquidation, just as in a fund. It is still a company, and may still have an operating business, but it is not reinvesting its capital; therefore, it does not have a growth rate that can be reflected in its return on equity (ROE). Generally speaking, there is a tendency for these securities to trade at a discount to net asset value.
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