At his recent presentation at Trinity College in Dublin, Mohnish Pabrai explained how investors can take advantage when markets get confused between risk and uncertainty, saying:
Q1 hedge fund letters, conference, scoops etc
If you have a business which exhibits very high uncertainty then that business generally will get very extreme kind of valuations in a auction driven market and an investor can take advantage of it.
Because markets get confused between risk and uncertainty. They get confused between these two. To give you an example. I made an investment a few years back. I think this was like in 2004 or so, maybe it’s been 14-15 years.
There was a steel company in Canada called IPSCO and the kind of nuances of this company were as follows, that the stock was trading at $45 a share, the company had no debt, it had $15 in cash, and it had contracted revenues and certainty of earnings in cash flows for the next two years. Which was $15 a share each so the company would make after-tax $15 in each of the next two years.
So in effect I was paying $45 and if I just held the stock for two years I would have $45 sitting in the company. But I would still have all the plants and everything else. But the business was extremely volatile. With extreme cyclicality.
So after two years there was no certainty of any kind of what earnings were going to be. Wide range, unknown and markets don’t like that. So what did the market do?
It priced it at $45 and from my perspective I said okay why don’t we just buy the stock and wait for two years and because I have all the plants, I have everything else. I just want to see what happens after that.
Because it doesn’t look like they have too much downside. So we bought at $45. A year later the company announced that they had one more year of visibility. They want to have another year of $15 in earnings.
So now we’re in the money and the stock the stock went to $65. Because we now had in effect $60 coming in, and then in a few months it drifted close to $90 because I think markets probably started realizing this is ridiculous.
Because you’re not giving any value to the plants and all of that, and some Swedish firm came and offered $160 for the business, and the stock immediately went for $153 or something.
I didn’t even wait for the deal to close. We were out of there and I still don’t understand why that Swedish firm didn’t come and buy them two years earlier. But that’s the way it is in life. Like Mark Twain says – truth is stranger than fiction. because fiction has to make sense. So uncertainty really bothers markets there.
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Article by The Acquirer’s Multiple
