It was early 2015 and plaintiff law firm Slater & Gordon was on the march.
Its shares had tripled in value in little more than a year and had become the biggest position in Wilson Asset Management’s portfolio.
So when Slater & Gordon struck an ambitious $1.3 billion deal to buy a UK law firm Quindell, and funded it with a two-for-three rights issue, it was hugely important for Wilson Asset Management’s then senior equity analyst and dealer Martin Hickson.
Was it a good or a bad move, and how good or bad?
Over at stockbroker CLSA, the newly-formed small caps team was also watching closely.
Led by analyst Oscar Oberg, CLSA thought Slater & Gordon could pick up some of the embattled Quindell’s better cases on the cheap and turn a profit.
Instead, it signed a whopping takeover for Quindell’s entire professional services division and got shareholders to fund it.
CLSA’s Oberg focused on Slater & Gordon’s cash flows and grew increasingly critical of the deal.
So too did Wilson Asset Management. It sold out completely on the back of its own work and with the help of CLSA, which it considered a rare independent voice in the market.
It was a decision that saved the fund millions.
Within one year, Slater & Gordon would write off $876 million of goodwill associated with the acquisition. Within two, the company was in the hands of its lenders, and today it is worth a fraction of what it once was and is 95 per cent owned by distressed debt hedge funds.
Fast forward three-and-a-half years, and Hickson and Oberg sit side by side at Sydney-based funds manager, Wilson Asset Management.
The pair – aged 33 and 34 – have been given the keys to Wilson Asset Management’s small caps strategies; the listed funds WAM Capital, WAM Research, WAM Microcap and WAM Active, and an unlisted fund, worth about $2 billion combined.
Oberg – a self-professed “concrete cowboy” who was a misfit on the family’s merino sheep farm near Yass, about three hours south of Sydney – focuses on the research part of WAM’s strategy, while Sydney born-and-bred Hickson, whose introduction to the sharemarket came trading stocks while at university, cut his teeth on WAM’s dealing desk and has a better feel for markets.
So they hunt for stocks as a twosome.
They think about the portfolio as evenly split between research and market-driven ideas. It is the WAM way, as laid down by founder and chairman Geoff Wilson, who still eats chilli scrambled eggs with the team every Friday morning at the weekly catch-up meeting where they go through every stock in the portfolio.
Hunting for ideas means company meetings, and they do plenty together.
Shoe leather approach
The pair has a list of more than 50 companies to follow up after the recent reporting season. The list took them to Melbourne last week to see IDP Education, Boom Logistics, Southern Cross Media and Mayne Pharma, among others, and has them in Brisbane this week.
They believe their edge – and the edge of WAM’s 11-person investment team – is that they’re nimble. They can react quickly when needed and move with conviction. Their default position is cash – where they say they can make about a 2.7 per cent annual return at the moment – and they only invest when they know they can make more. The process is also index unaware.
Their biggest holdings include Seven West Media, retail chain owner Super Retail Group, fast food store operator Collins Foods and mining equipment business, Emeco Holdings.
Seven West and Mayne Pharma fall into the research-driven bucket, which considers three main factors; a company’s PEG ratio (its price-to-earnings multiple divided by the growth rate, its management team and track record, and the quality of the company and its industry. They also want to see a catalyst, such as an earnings upgrade, and tend to hold stocks for one to three years, Oberg says.
“[Seven West] is a turnaround story,” Oberg says.
“The stock is cheap. Our view is that the balance sheet has been under pressure for some time, but now you are getting some earnings growth turn positively.
“There is a lot of operating leverage in the business and costs to take out. We also see a very strong TV market, which is continuing – and a strong outlook for the business. And their earnings guidance, which they released at the result, we think was particularly conservative.”
Oberg says the fund bought into Mayne Pharma in April after researching some of its US-based peers, and reckons investors should watch for some bolt-on acquisitions.
“It felt like things were stabilising after one or two years of heavy price deflation,” he said.
“It had a very strong cash flow at the [recent] result and that certainly mean the balance sheet is in a pretty good state. And a lot of the majors in the US are shedding assets as well, so we think there is a strong acquisition opportunity and the market stabilising.”
Super Retail Group – one of the manager’s biggest holdings – and Collins Foods are more market-driven ideas.
Hickson says Super Retail is cheap, trading at 12-times forward profit, and all three divisions (leisure, sport and auto) are firing at the same time for the first time in a long time.
“The catalyst for Super Retail was when they bought Macpac [in February],” Hickson says.
“That’s when we bought in. We thought it was a high quality acquisition; one of their largest competitors, Kathmandu, was achieving strong earning and like-for-like sales growth and we thought they could over achieve on the acquisition.”
He said more recently the fund had been buying Collins Foods shares.
“The catalyst there was the investor day [held last week],” he says.
“At the result, Collins Foods was talking to the success they were having with their one Taco Bell restaurant on the Gold Coast and we thought there was an opportunity for Collins to roll it out more widely across Australia.”
Collins announced plans to open more than 50 new Taco Bell stores before December 2021 last week, which sent the shares up 5.6 per cent on the day.
And when it comes to management teams, the pair say their favourites include Emeco Holdings boss Ian Testrow, Cleanaway Waste Management’s Vik Bansal and Corporate Travel Management founder Jamie Pherous, all for different reasons.
Pherous turned a small Queensland-focused corporate travel business into a global player, Bansal refocused a perennial underperformer, while Testrow saved Emeco through a string of acquisitions and divestments that reshaped its industry.
The question on Oberg and Hickson’s minds – and the minds of fund managers across the market – is how much longer the bull market can run. They’re cautious, but say the bull market has further to run.
But in the meantime, they’re watching for signs of exuberance.
“Balance sheets are in pretty good shape. We are not seeing companies go out there and make rash decisions, gear up the balance sheet and bet the farm offshore,” Oberg says.
“I don’t think we have seen that in spades as yet. That would certainly be a warning sign for us.”
Which makes it sound like the episode that brought them together is still fresh in their minds.