People are queuing up to invest together with Thomas Tang at MediumInvest. When you look at his past performance, you understand why. MediumInvest exploits the inefficiencies in the Scandinavian small cap market through a value investor approach.
I talked to Thomas Tang about how he invests and about some of his favorite holdings in the portfolio. Read the highlights from our conversation below.
The text has been translated and edited for clarity and length
What kind of companies do you like to buy?
“We invest in companies listed in Denmark, Norway, and Sweden with a market cap below 1 billion Euro. The investment universe has around 1000 companies. There are simply not enough companies to focus only on very specific company characteristics. We focus on the individual case.”
“We see ourselves as value investors. We buy companies that are trading at a big discount to their intrinsic value. They can also be growth companies as long as we have a clear picture of what they are worth and they are trading at a big discount. But we have a bias towards classic value cases as there is more mispricing to be found in this area.”
“Basically, if we understand the business very well and the discount is big enough, we will invest. With growth companies we usually understand the business fundamentals but often the discount is not big enough. In other cases, like biotech, we have a hard time even understanding the case. It is too difficult to assess the potential in the pipeline. You almost need a PhD in the related area.”
“But again, if we understand the case and the discount is big enough, we will have a look at it. Before we started managing external money, we owned Genmab. It was valued almost equal to its net cash position, so you got everything else for free. It is very rare that you get this kind of opportunity. Now it is a C25 large-cap company. We sold it in August 2013 when our part of the case had played out.”
How many stocks do you typically hold in the portfolio and how large are the biggest holdings?
“We have 15 to 25 companies in the portfolio. The largest position can be up to 15%, but only if we really like it a lot. Otherwise we use 10% as a maximum weight. Liquidity is an important factor for us. The more liquid the stock is, the higher the weight can be. Our requirement to liquidity depends on the upside, our conviction in the case, and the likelihood of fundamental changes to the case.”
Why is it interesting to invest in small-cap equities and what do you need to be aware of?
“Primarily there are two reasons why small-cap equities are interesting. The prices are not as efficient as in large-caps, and historically, as an asset class, small cap equity has delivered a higher return than large caps. The disadvantages are mainly the liquidity issues and the higher volatility. We deal with the liquidity by limiting the AUM in the fund, we size our positions right and we have a long-term focus.”
“The less efficient small-cap market and less focus from other investors give us a huge advantage. In the largest stocks, it’s difficult to find something the market does not know, but in small caps it’s easier. We have the luxury of being able to be among the most well-informed investors, who know the most about the company we invest in. That is extremely difficult with the large companies, but we can actually do it in a lot of the companies we invest in.“
“Both the quality of business models and corporate governance are more mixed in the small-cap segment. Large companies have typically proven their worth. Small companies are often in the process of proving their worth. Also, in the very small companies, the growth dreams are often big, and you need to adjust for this in your assessment of the company.”
“We look at the level of corporate governance by assessing factors like the capital allocation. But we also look at companies that are improving corporate governance, such as those that are starting to pay out excess cash.”
How do you find new investment ideas?
”We use four different types of idea generation. One way is to follow the news and read company announcements. Occasionally you can find some really good cases that you would not find otherwise.”
”One example is Brødrene A&O Johansen. They bought back 50% of their own shares. They bought them from two competitors at an attractive price. It created a lot of value, but it did not show up in the financial numbers until much later. You have to follow the news to notice it.”
”Another example is North Media, which we will talk more about later. PostNord backed out of North Media’s primary business area. This changed the industry structure from a duopoly with price war to a monopoly with no competition. We look for news that can transform companies and that can create investment opportunities.”
“We also get ideas through a network of like-minded investors, where we can share cases and discuss potential investments. The third way is following insider trading. We don’t follow insider buyers blindly. We use them to find shares that are interesting to take a closer look at. If we both see heavy insider buying and we like the case, then there is a good chance the investment is attractive. The final source of ideas is screening.”
What do you do when you start to analyze a new company? And how long does it typically take?
“When we look at a new company we usually start out by reading the latest annual report and the latest quarterly report. From there it depends on the case. Often the next step would be to understand the industry and the industry dynamics. Try to understand the competitive situation, the long-term outlook, that kind of thing. But again, it depends on the case.”
“Essentially, it’s about getting an understanding of the company and how it will develop going forward. Will it grow the top line? Will it increase margins? How do we see corporate governance? What is the actual value of the company and how does the market price it? It varies a lot how much work it takes to get that understanding.”
“We follow some companies for years before we invest. Other times, when there is news that can transform a company, we can move very quickly. Sometimes in the small-cap space, we can buy the shares before the news is reflected in the stock price. One example is Viking Supply Ships. They sold some ships to the Canadian government at a very, very good price. Suddenly the shares traded significantly below the value of the company’s net cash position. I think we spent 15 minutes looking at Viking Supply Ships before we bought them.”
“Again, we must understand the company and the industry. So, the simpler the case is, the better. If we have to go into long and complicated dynamics, then the risk increases.”
How do you look at valuation?
“We are not fans of big discounted cash flow models. You cannot use the results for much as the model is based on too many inputs with a high degree of uncertainty. Or perhaps you can use it, but if you make a simple multiple model and have a reasonable idea about the company’s future outlook, then you basically can get the same outcome with much less effort.”
“We look at something we call normalized earnings or normalized PE. We try to adjust for temporary effects to get an idea of the underlying earnings. And if we understand the company and the outlook and we have comfort in the level of normalized PE, then we actually have enough to decide if we should invest or not.”
“The current level of normalized PE in the portfolio is around 10. We do not have a target or maximum for the normalized PE. It depends on the case and the growth in the company. If the company has a fantastic future, we are willing to pay 20 or 25 times normalized PE. If we take a company like North Media, which will be very profitable this year and will grow the profit next year, but in the end operates in a stagnant market, we would never pay 12 times normalized PE.”
“When we go from earnings to normalized earnings we start by adjusting for things like non-recurring income or expenses. And we consider if the non-recurring expenses really are one-offs or recurring. We adjust for factors like amortizations of items that are only on the books because of past M&A activities. We look for changes in the capitalization of development costs. We also try to get an idea of the margin level across the entire business cycle. That is probably the hardest part because the time horizon is so long, and each cycle is different. Basically, we try to find the company’s true underlying income over time.”
What is the investment case for North Media? (NORTHM:DC)
“North Media’s main business is the distribution of printed matter (unaddressed advertising material and newspapers) in Denmark through the company FK Distribution, which makes up close to 80% of the revenue. They’ve got three other business units. Local newspapers, BEKEY that sells electronic access systems, and an online segment of which boligportalen.dk (rental properties), is the most important asset.”
“For a number of years, PostNord (the Nordic postal company) tried to enter the Danish market for printed matter. This led to an intense price war with North Media. PostNord lost a lot of money while North Media still made money, but the profit declined significantly. Last year, PostNord announced that they would exit this market. That means North Media once again has a monopoly. They could both raise the prices and increase the volume, as PostNord’s customers needed a new supplier. This will lead to large increases in profit both this year and probably also next year.”
“The market cap is currently around DKK 625 million and at the end of the year, they have a net cash position of DKK 200 million (mainly placed in stocks). If things go well, they will have an EBIT of up to DKK 150 million in 2019. If things go well, the enterprise value to EBIT will be around 3 and in a mediocre scenario, it will be closer to 4. That is a classic example of a company with business transforming news that is not yet fully priced into the stock.”
“The 3 smaller business units are not well run and lose money. We assign a negative value to these segments. I do think there is a chance that they could make money in the future. But given the current history, we are not taking it into account in the analysis.”
“The company’s large investment portfolio also makes us put a discount on the valuation. In their defence, the cash and stock portfolio made it possible to keep fighting the price war until PostNord abandoned the market. They also started to pay out dividends. As mentioned earlier, it is important that the shareholder friendliness moves in the right direction.”
What is the investment case for Note? (NOTE:SS)
“Note is a Swedish company that assembles electronics for their customers. They work as a manufacturing and logistics partner. The industry is super interesting since the use of electronics will just continue to grow and grow for many years to come.”
“The majority of Note’s factories and sales are in Europe. It has become relatively more attractive to produce in Europe and less production is moved to Asia. Note benefits from this trend.”
“The underlying growth in the industry is good and Note has both double-digit topline growth and increasing margins. They have very little debt and a dividend yield of 5%. You can buy the shares at close to 9 times normalized earnings. We believe it’s very cheap. The biggest risk is a potential slowdown in the inventory cycle. In the long run, the growth will be there. So, we can live with some cyclicality.”
“Note just bought a small competitor. This gives an additional angle to the investment case. They only paid 5 times EV/EBITDA, as it was a small company they bought. If they can integrate it without major issues and perhaps even get some synergies, then the acquisition can be quite value creating. Also going forward if they do more M&A.”
“This is an example of a well-run company – it has low financial risk and is shareholder friendly. It is incredible that it can be so cheap. We are very happy to own Note at the moment and think it will perform well going forward.”
What is the investment case for Kongsberg Automotive? (KOA:NO)
“Kongsberg Automotive is a supplier to the automotive industry. By the end of 2016, they got new management that put a turnaround plan into action. Kongsberg Automotive had margins far below the industry average for many years. The plan has gone according to schedule in the last two years. The new management has done a great job and they also bought a lot of shares in the company.”
“We estimate that Kongsberg Automotive trades around 5 times normalized earnings. The normalized earnings level will be achieved in 2019 or perhaps 2020.”
“Car manufacturers usually trade at low multiples as a group. And if they had the same characteristics as Kongsberg Automotive, the low multiple might be justified. However, the suppliers in the industry trade at much higher multiples. If Kongsberg trade at the same multiples as their peers, the upside is almost 100%. It is not industry factors that will drive the repricing, but the company-specific turnaround case. When the results show up on the bottom line in the financial reports, the stock is likely to reprice.”
“The biggest risk factor is the business cycle, which at the moment also depends on the risk of a trade war and how it will impact the automotive industry. We have gone through Kongsberg Automotive’s ten biggest customers to see how they are doing. All of them have good topline growth or increased their revenue guidance. On the profit side, it’s more fifty-fifty between positive and negative guidance revisions. In the short-to-medium term, Kongsberg Automotive is most dependent on their customers’ topline growth, so all else being equal this indicates that they don’t get impacted negatively at the moment. They are also seeing high growth in new orders, which underlines the growth potential.”
MediumInvest is an alternative investment fund and has DKK 200 million under management. It was founded five years ago and is located in Århus, Denmark. MediumInvest focuses on small and mid-cap equities in Denmark, Norway, and Sweden.
Founder Thomas Tang has managed the portfolio since the beginning. Philip Woloszynski Tadayoni is also part of the investment team, and is located in Copenhagen.
Since its launch in September 2013, MediumInvest has given a return of 236% compared to the benchmark return of 73%. This translates to an annualized return of 27% compared to 11% for the index.
The fund currently has a long waiting list of interested investors. Thomas Tang does not believe MediumInvest has hit the maximum AUM level yet. However, they prefer to increase AUM slowly to make sure they do not get too big and lose their edge.
MediumInvest has an unusual cost structure. The low fixed costs of 0,4% just covers the actual fixed costs of running the fund like rent, IT, and legal fees. The managers mainly get compensated through a performance fee of 25% of the excess return, compared to the benchmark, using the high water mark method.
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