Value investing takes discipline. A buying strategy for most value investors is simply buying a company at prices significantly below the intrinsic value, or the fair value the business would sell to a rational buyer. A lot of the companies that we explore are not only usually trading significantly below intrinsic value, but are also secondary stocks that have usually been left for dead in the market. So buying is easy as long as there are enough companies that qualify our criteria.
However, the difficult part comes in selling. When is it right to sell? Do we sell when the gap between value and price has closed, or do we adjust the value of the company based on improved expectations as perceived by the general market? At ValueHuntr, we prefer the first, except when the underlying fundamentals of the business may justify an adjustment to our estimated intrinsic value, such as in the case of winning litigation, federal tax refunds, etc. So the positive side of this discipline is that we, as rational buyers, know at all times that we sell the business when value has been realized. On a negative note, there is no natural law that prevents the company’s stock to continue climbing only because the gap estimated value and price has been closed. This is exactly what happened with our position in XTNT, which we closed on March 25, 2009 for a 77% return after only two weeks of having added the company to our ValueHuntr Portfolio.
We added XTNT to our portfolio because the company was trading below liquidation value, and the company had engaged Piper Jaffray & Co. to help the company pursue strategic alternatives which may include the sale of some or all of the company’s assets or other types of merger or acquisition transactions intended to maximize shareholder value. We estimated that the company was worth no more than $15M at liquidation. At eh time, the company was selling for $9M, so as long as the company traded below its liquidation value, chances were that we would still be able to realize some gains in the near term. Two weeks later the company was trading at $17M, and we decided to close our position.
Five days after we closed our position, XTNT is now a $33M company, so its value has doubled since we close our position five days ago. Though we believe the company does not deserve to be trading higher than its net asset value because of its poor earnings prospects, the company is now trading at 1.3X book value. We would have loved to have realized this additional 100% growth in market value that occurred after we closed our position, it is also clear that XTNT’s underlying fundamentals are not consistent with the company’s current price of $1.45/share. Do we wish we kept XTNT for longer? Yes. But keeping the position meant going beyond, if not disengaging, our discipline of paying bargain prices for neglected, secondary businesses. Overall, we prefer to sell early than to buy late, so we are happy with our 77% gain.
Valuehuntr: agreed selling is harder than buying, but my view is that this was a situation in which the facts at XTNT changed which should have changed the analysis. After XTNT received CE Mark approval the stock jumped from roughly .40 to .70. XTNT had .81 per share cash 12/31 and will have an estimated .60 for quarter ending 3/31. This valued the CE Mark approval at appx. a dime, (.70 market minus .60 in cash) or 2mm dollars. XTNT spent maybe 40mm getting the unique stents to the point where they had CE Mark approval, to market the stents to Europe, the rough equivalent of FDA approval here. It was apparent that the market’s valuation was too low, because Piper is actively pursuing strategic initiatives, so the catalyst to quickly realize this value beyond the dime was already in place.
Also, selling is not all or nothing, I sold half of my position today. I’m also not playing Monday morning quarterback, I made these views clear at another value site before the stock move.
If it turns out no one is interested in the stent technology with CE Mark approval, the stock will tank, to reflect the value then, but with the catalyst in place the stock was too cheap not to hold.
Good point JM. The problem with adjusting XTNT’s value after receiving CE Mark approval is that you are counting on the future expectations of the business, and that is something I would prefer to stay away from. Kudos to you though for staying with the company.
Pingback: Is XTNT a Bargain Once Again? «