Cube Report (18 Dec) – A good argument against micro-caps
I’m a little sad today, to see that United Carpets (UCG) is leaving us and going private.
I don’t have any position in this stock, but it was one that I used to follow quite closely, and used to own. Back in the days when hunting for value in tiny companies was my M.O.
Why did I stop investing that way? It was a gradual thing, as I figured out what worked for me and what didn’t. And to be clear: I have not completely given up on that style: I’m privileged to be able to review lots of different opportunities, and if I stumble across something that appeals, regardless of the category it falls into, I’ll consider it.
Indeed, my current portfolio still includes a couple of micro-caps which could be called value plays.
But the truth is that I’m now a lot more interested in bigger, quality companies. I guess because they are often easier and lower risk.
- Easier. They publish more information for their investors, and more information is available about them. The flip side of this is that large companies can sometimes be more complex, with multiple moving parts.
- Lower risk. You can (generally) expect more professionalism from the executives and you can expect larger businesses to have more access to funds, if they need it. More diverse product lines and a longer track record are other traits typically associated with larger businesses.
Lower risk is often said to be associated with lower expected returns, but even this is disputed – for the simple reason that many risky companies at the lower end of the market attract far too much capital, and therefore have low expected returns. Quantitatively, the evidence given for this is that the most volatile stocks, taken as a group, tend to underperform.
This brings me to UCG. A tiddler that nearly went bust in 2013 (technically, its operating subsidiary did go bust), before rising from the ashes. It then suffered a slow decline before running into the Covid disaster.
It has pulled through 2020 in reasonable shape. But stock market investors are now being asked to leave, with a tender offer at 6.25p.
The first reason given:
· the Directors believe that the Company is not of a sufficient scale to attract interest from institutional and other investors and consequently suffers from a lack of liquidity for its Ordinary Shares;
It is then noted that the Founder’s family owns 64.7% of the company already, which hurts liquidity, and:
· the considerable costs, management time and the legal and regulatory burden associated with maintaining the Company’s admission to trading on AIM which are, in the Directors’ opinion, materially disproportionate to the benefits to the Company and given the economic climate are becoming increasingly burdensome;
Honestly, I couldn’t agree more.
There is no way, in my opinion, that a small company should spend hundreds of thousands of pounds each year, and deal with all of the public market compliance, unless it has very serious growth plans.
When UCG was making pre-tax profits of £1 million+, the benefits of being publicly listed could possibly have been justified, if it did have serious intentions to grow.
In a weaker economic environment, and lacking that growth impetus, there is no good reason to be listed.
And while it makes good logical sense, this is a serious risk for micro-cap investors: that the company directors might take the company private again, at any time. And if they do, your ability to negotiate on the offer price might be very limited indeed.
Sometimes they will do the honourable thing and offer a reasonable price (and that is probably the case with UCG), but sometimes they won’t.
So my tip for you, dear reader, is to ask yourself, when looking at any micro-cap: “Why is this listed? Does it really need a listing?”
If there is no clear purpose to its listing, then maybe you can’t assume that it will stay listed. And maybe that’s a problem.
As for UCG, I doubt that I will ever see it again. So I bid it adieu.
Here’s the Founder, Paul Eyre, back in 1993. Keep up the good work, Mr. Eyre!