The first broken thesis: RNY Property Trust

Hokey dokey, so, today ticked off two dubious ‘first-evers’ in investing for me:

  • First time I held a company that fell 70% in a day.
  • First time I held a company that fell 70%.
RNY has gone lame, and may have to be put down.

Not the kind of boxes you want to be ticking. RNY Property Trust (ASX: RNY) went tits up, slipped, and fell off a cliff. As for me, I slipped and fell off the bandwagon. The update on marketing efforts was pretty grim.

Just a re-heat of the original thesis,  RNY is selling properties in order to pay off a loan called ACORE (there are some other properties and debt but ACORE is the main one). Leftover cash on top of the ACORE loan (if properties are worth more than the loan) is how shareholders make their money and prior to today I thought there was a good chance of getting substantially more than the 3.3 cents I paid for shares. However:

“The bids for the Long Island assets (6800 and 6900 Jericho Turnpike, and 55 Charles Lindbergh Blvd) and the Westchester assets (560 and 580 White Plains road) ranged from approximately 15%-50% below valuations. 

If sales of these assets were conducted at the bid prices, net sales proceeds would be insufficient to pay the ACORE mortgage debt encumbering such assets. 

…If the above-mentioned assets were sold at the high bid pricing, then projecting sales proceeds, the payment of debt, selling expenses, and other liabilities and expenses would result in an NTA per unit between A$0.01 and $0.03.”

Straight away, the thesis is broken. In my original valuations I considered these outcomes likely:

  • 6800 Jericho – unknown but figured a 25% discount
  • 6900 Jericho – considered firm, perhaps 10% discount
  • 560 White Plains – considered 50% discount likely
  • 580 White Plains – considered 20%-25% discount
  • Charles Lindbergh – considered no discount, maybe even higher price due to re-sign of Lockheed and additional tenants

 

For the first four properties I considered these outcomes to be kind of lower down the probability scale, due to the signing of new tenants etc that had been happening. Yet the news that the high bid for Charles Lindbergh was at least 15% below December valuations effectively shattered my thesis, as this was the most valuable property by far.

What to do now?

In my view, since I have totally misjudged the state of the property markets/ values for these properties, to hold on from here would be sheer stubbornness on my part – I’ve already seen stark evidence that the thesis is broken, not just looking a little wonky.

The next question is, what to do now?  We’ve been told that units are worth between $0.01 and $0.03 based on the remaining property values. Things certainly could get a lot better. However, with the thesis already broken, I think it would be foolish of me to continue holding.

There is a good case for holding, capitalisation rates are high and the properties obviously have value from a cash flow perspective. There are also the ISB properties to consider. I may take a few days to think over this and absorb some lessons, but at this point I believe I am exiting RNY in the near future.

What can I learn from this? 

A few lessons jump out immediately.

  • I may have overlooked one thing in my initial thesis – that local area buyers would be well aware of RNY’s trouble and be motivated to bid low.
  • I should have suspected that maybe the correlation between property values in Long Island/Westchester  would be pretty strong. I.e., if one requires a big discount to sell, they might all require a big discount (e.g. because property market is weak).
  • Because of the correlation, the chance of success was lower than I previously predicted
  • I assumed that the property market was rational (I know, I know). I looked at rental yields (among other things) and thought these properties were great value. However if the market thinks Long Island property is shit, yields won’t matter in the short term – but asset values matter, a lot, cos RNY has to pay its debts.
  • Following on from the above point, there was effectively a mismatch in liabilities, which I did not weigh appropriately. I.e., debt came due sooner than the property values might have been realised, which means that this investment’s outcome was governed by debt not the net asset value of properties.
  • Something I’ve commented on previously – there comes a point when extensive research does not improve your predictive ability. So I may have learned a little more about what types of outcome are really determinable by research (in hindsight this one may not have been).
  • Look for less binary outcomes (there is no saviour with RNY such as a dividend or takeover/turnaround potential etc which may have compensated for an adverse event and made holding and not crystallising losses a viable choice)
  • Thank God for position sizing (‘free lunch’)

 

Having to tell people you’re selling your shares sucks, especially with small microcaps. I was tempted to do a [redacted] and tell you when I buy my shares but brush it under the carpet/not notifying you when I sell – ah, but then I remembered that I’m not a cretin.

In the future I may consider selling the failed investments first and then writing about it later – I’m running this portfolio for my benefit, after all. However you have my word that I continue to strive for the highest standards of integrity, and I’ll make a decision on that in the near future.

Disclosure: I own shares in RNY Property Trust. This is a disclosure and not a recommendation. FYI, RNY is so small and such low liquidity that you won’t be notified before I sell it. 

Quarterly review: Q4 2017

3 months since my first purchase, it’s time for a review of the quarter ended 30 June 2017. I have called it Q4 in reflection of the fact that it is the final quarter of FY17, although it is in fact the first quarter of my portfolio experiment. There’s really not a lot to report so far – if you just look at the performance and allocation charts below and read nothing else, you haven’t missed much. It is however, a lengthy post due to the many ground rules I am setting down for reference in the future. It will be good practice for future updates when there will be much more happening – although hopefully, the updates will become much shorter.

Without further ado:

Performance

The performance of the 10foot portfolio vs its primary index, the ASX200 net total return index. (from Google Portfolio. click to enlarge)

Surprisingly the portfolio slightly outperformed over the quarter, a pleasant change from April and May where it was taking a hammering. I have 73.7% of the portfolio in cash and it is earning a nominal rate of 2% interest per year.

It is not actually earning this money; the only real money in the portfolio presently is in the shares I own. I am currently working and saving to add the remainder of the ‘cash’ to the portfolio. For the purposes of this experiment though I will add 0.5% per quarter on the balance of cash at the end of the quarter as this is the simplest way of incorporating cash returns into my performance.

I have chosen to benchmark against the S&P/ASX200 Net Total Returns (INDEXASX: XNT) as this seems the most robust benchmark for a small portfolio. The others like S&P/ASX 200 (INDEXASX: XJO) and S&P/ASX Small Ordinaries (INDEXASX: XSO) have various issues such as their dependence on resource prices. I am tracking those also, I am just less concerned about them:

10foot portfolio vs the ASX 200 and the Small Ordinaries (source: Google Portfolio. Click to enlarge)

As you can see, I’m still heavily in cash:

Investing it steadily. (source: 10foot portfolio and Google)

Probably the first thing to bear in mind is that I’m starting with a big headwind, in that brokerage of $14.95 represents 3% of a $500 purchase, and another 3% when I sell. Were I index hugging and turning the portfolio over regularly, I would expect bad underperformance (note to self: avoid both of these things at all costs).

If I owned 20x $500 investments and made 1 buy and 1 sell in a 5 year period it works out to be about a 6% fee, or 1.2% of my starting asset value per annum. That’ll increase if I sell companies in a couple of years time and buy new ones, as I might have to do if a thesis breaks, etc. So I need to outperform by, just say, 1.5% p.a. in order to break even after fees. If all I did was match the index after fees I would consider this experiment a failure.

I’m excluding the benefits of franking credits and tax from my returns.

Note on the rules:

I follow a large number of Australian investors, and my aim is not to buy companies that have been ‘recommended’ to me via blog posts, quarterly reports, or whatever. I accept ‘tips’ e.g. ‘hey check out XYZ’, but the goal is complete intellectual honesty on the stock picks (You’ll just have to take my word on whether I achieve it). Unfortunately, this rules out a large number of the good companies. On balance I would consider it likely that I’ll own more ‘value’ or unpopular stocks over time, though we will have to wait and see how that plays out.

I said in The Rules that 80% of the portfolio (the total portfolio when it’s complete) must be both paying a dividend and profitable, or have good prospects of doing both in the next 12-18 months. This is to help prevent me focusing too much on speculative/high risk companies or focusing unduly on share price as a measure of success. So far I’m mostly on track, although if I continue investing in really small companies the dividend edict may become a bit of a drag (e.g. if the companies are investing heavily in growth).

I may change my mind about that part, but here’s how it looks so far:

Company Profitable (80%) Dividend (60%)
Thorn Yes Yes
RNY Trust No but CF positive at EBITDA level No
Eureka Yes No but likely in next 18mths
Probiotec Yes Yes
Crowd Mobile No but likely in next 18mths No

Here is how each company has performed in share price terms as at 30.06.2017:

source: 10foot portfolio and Google Finance (click to enlarge)

*note that buy prices are inclusive of brokerage on the buy but excludes brokerage on the sale (b/c I haven’t sold anything yet)

**There is a difference between the above prices and the performance of the portfolio vs index because these prices are taken as of market close on 30.06.2017, whereas the portfolio’s returns were captured 03.07.2017 (I forgot to record at June’s end). Portfolio returns also include interest on cash held.

A range of likely outcomes

I thought very hard about whether to include this section as some readers might view it as misleading. I eventually decided it was an important part of my accountability to myself to include it. This is a table of my opinion of possible outcomes for the shares I hold, if everything goes wrong or everything goes right over the next 5 years.

It is not a reflection of what I think the probability of these outcomes is, nor does it reflect my estimates of intrinsic value. It is simply ‘if everything goes right/wrong over the next 5 years, how much do I think could I reasonably stand to gain/lose?‘. There are no ‘lottery ticket’ assumptions (e.g. takeover bid/ possibility of major fraud) built into these ranges, but it does consider dividends, fire-sale value of assets, exec departures, cap raisings, working capital blowouts, loss of major customers, etc.

It is a very imprecise measure and things could always go better or worse than I expect – and of course, in the final case most companies have a possible 100% downside. This is just an illustration:

Company Everything goes right Everything goes wrong
Thorn Group Ltd investment could 2x lose 50% to 70%
RNY Property Trust 2x-4x lose 90% to 100%
Eureka Group 2x-3x lose 50%
Probiotec Limited 2x-4x lose 50%-90%
Crowd Mobile 2x-4x lose 70%

As I said, this is purely an illustration, not a prediction, forecast, or reflection of my value estimates. It is simply to check I’m targeting the right sorts of outcomes. At a glance I could already say that I need more investments like Eureka Group and a greater focus on protecting the downside.

A comment on risk

As you will gather if you’ve been following my buy theses, I have focused strongly on controlling price risk so far. That is to say that, (in my opinion) should these businesses continue with no change in circumstances, on balance I consider that there is very little chance of shares falling substantially (except RNY), and possibly even a chance of making $$ just from reversion to mean P/Es.

However, despite that, I can see from the above table that there are still plenty of possible outcomes where I lose 70% or more. This is due to other risks such as operating deleverage if revenues fall. Many companies have similar downsides, true, but I think I could do better in this respect. I have made a note to look for more investments that won’t penalise me quite so much if I’m wrong. I will focus more on fixed, moderate downsides (like Eureka) while retaining the potential for multiple bags on the upside.

And now, a brief comment on the companies themselves, and an important consideration for each – would I double down?

Thorn Group Ltd (ASX: TGA) – up 6%

Thorn reported its results in this quarter, by and large they were as expected although there was impressive growth in the business finance sector. Funding could become a problem in the future as it is running out of headroom on its warehouse facilities, which is is the key element in a bear thesis I recently discovered for the company. There are no changes to my Thorn thesis and, owing to the vagaries of the market, I’m currently showing a small profit on that one at present, instead of a 10% loss as I have been for most of the quarter.

Would I double down? Not without a major step change in either value or business situation.

RNY Property Trust (ASX:RNY) – down 12%

No news for RNY, although a beefy fall in its unit price. I have been keeping an eye on industry publications/ local area media reports etc to see if I could perhaps get an informational advantage when the properties are sold, but no success so far. Ultimately the unit price falls are irrelevant – the value received for the properties when/if sold is what counts.

Double down? Not without further information on property values/ the sale process.

Eureka Group Holdings Ltd (ASX: EGH)- up 10%

Eureka recently announced an acquisition and a couple more in advanced stages. This adds 42 units or approximately 3% to the company’s total unit number, with room for an extra 8 units to be constructed. The ‘advanced’ possible acquisitions would add another 142, or +10%. Is proceeding according to plan so far.

Double down? I would, and at today’s prices too, but waiting for annual report and update on progress with acquisitions first.

Probiotec Limited (ASX: PBP) – down 2%

I only just bought Probiotec. I would consider doubling down, depending on how it progresses.

Crowd Mobile Ltd (ASX:CM8) – down 6%

On the 29th of June, just prior to quarter end, I purchased Crowd Mobile. Would consider doubling down here too, although not until after the next report.

The portfolio as a whole: 

Fortunately (or unfortunately, we will see) in my opinion there is a low chance of hugging the XNT index with these companies. Although some industries – pharmaceutical manufacturing, consumer credit, and retirement villages – should correlate highly with the domestic economy, in my opinion there are enough company-specific factors that should see their performance diverge (for good or for ill) over the next couple of years.

If I had to identify a factor behind the investing so far I would say that something like unloved/value/mispriced is the primary driver behind selection of these companies. Going forward I would like to pick up a couple more higher margin, higher quality companies, ideally with recurring revenue or a niche – healthcare, or maybe software.

I note that I’m approximately 25% invested so far and my target is to become approximately 30% to 50% invested in the first year. The rate of purchases should slow a little now, and at the present time I’m expecting maybe another 2 purchases and 2 double-downs over the next 9 months, depending on what crops up. That would see me about 45% invested.

It is early days yet and I have no real concerns about the portfolio either way as under-performance and out-performance at this stage represent little more than price fluctuations. Investment theses have not yet seen any serious confirmation or challenge to suggest I’m on the right/wrong track.

This has been a good trial run for the first quarterly review, and in the future I expect there to be both more news, and hopefully a little more conciseness.

You’ll read about these things as they happen. Please feel free to share your thoughts or criticism in the comments section below.

My results are not audited. I own shares in each of the abovementioned companies; Thorn, Eureka, RNY Property, Probiotec, and Crowd Mobile. This is a disclosure and not a recommendation.

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One that didn’t cut the mustard

A quick comment on one company I have liked for a while but repeatedly elected not to invest in; Rent.com.au Ltd (ASX: RNT).

Its premise is that it is a scalable online advertising platform that a) attracts a unique audience and its products have great cost-benefit ratio for landlords, and b) with rentconnect, online renter CV and other services, it is easier and quicker to apply + be approved for houses, and relocate (tenant benefit).

Heaven knows the entire rental industry is paper-bound, people-heavy, and extremely painful to deal with, either as landlord or as tenant. It is in dire need of disruption. I can get behind the premise, and the product, and I would like to own Rent.com.au, but I am not investing for several reasons:

  • Cash expenditure is obscene. Rent.com.au is earning about $1.4m in annualised sales, burned $6m cash (due to $7.2m in employee costs) at the half year, and has $3.3m cash on hand. Only $500k got spent on development and the company has had persistent heavy cash outflows in spite of its modest revenues. For one thing, the heavy employee expenditure does not look like the sign of even an early-stage scalable advertising platform.
  • Unconvinced of a genuine advantage. The ‘we rent your property 8 days quicker on our Smartplan’ looks good. However for a company that has 90% of all real estate agent listings and just 5% Smartplan penetration, Rent.com.au is experiencing very slow growth in quarter-on-quarter revenues. Either execution has been poor (possible), the product is not as compelling as it appears (also possible), or attracting customers to rent.com.au is much harder to achieve than expected (also possible).
  • Time taken to achieve results. Actually the company has hit/exceeded its goals of unique viewers etc since listing, but with that cash outflow and modest growth, I’m not willing to run the risk of going backwards with my investment in the hopes of going forwards.

I think the product is good and the potential to outperform over the next 5 years is there, but even at today’s market capitalisation of $13m I’m not willing to take a risk on Rent.com.au.

I’ll be waiting for the company to get closer to its break-even goal date, and seeing how the new CEO/ cost cutting goes before revisiting it.

I have no financial interest in any of the above companies. This is a disclosure and not a recommendation.

The 10foot review of my portfolio performance over the past quarter will be out this weekend.