Falling shares prices are driven by failing management and ineffective boards. Aren’t they?
Or are shareholders failing companies?
I have recently focused on company boards failing shareholders and the value I believe can be unlocked through positive engagement with shareholders. I have recently experienced two different forms of engagement. The first is with Avacta where I attended their superbly organised and well attended, live-streamed AGM and secondly with Bidstack, where more proactive engagement was required to drive change. Both engagements clearly highlighted positive operational momentum and a desire to improve investor communications but the result on their share prices? The same. Continued share price drift. What is going on?
As Carl Jacobi famously said, though more famously quoted as Charlie Munger, “Invert, always invert”. If there is evidence of companies failing shareholders, what is true of the inversion? Are shareholders failing companies?
Let’s continue with these two examples. Avacta and Bidstack are not the proven, cash generative businesses that we ordinarily highlight as investment ideas. This is exactly why engagement and narrative are so important – the absence of a track record of financial performance leave engagement, regular communications and a narrative as the only tools in the toolkit. While acknowledging the risks and certainly not making any recommendations, I could argue that there are few, if any, other companies listed on AIM with greater value upside. I am sure many will disagree and point to other ideas. That is the joy of investing and how markets work – debating different opinions, changing views with additional evidence, and eventually time provide the answers. That, however, is not the question to be answered here. Rather, given the current evidence, why are some valuations so demonstrably poor?
Let’s take Bidstack first.
A conversation with another shareholder highlighted the obvious question of the current valuation considering the valuation of the company’s closest peer, Anzu. There is little doubt that the current Bidstack valuation is of the company’s own making, which the recent shareholder engagement by a group of individual investors sought to address. While the progress from that engagement is yet to be demonstrated, there are many who believe that Bidstack simply won’t ‘make it’ given the performance to date. Some are stating furtively that the company may need further funding and it will come in the form of ‘death spiral’ financing. There’s nothing hidden or sinister about the funding requirements. The company has announced in black and white that they are negotiating a CLN (Convertible Loan Note) with a strategic investor.
As an aside, I remember a time when a CLN was a relatively straightforward instrument that highlighted the investor’s confidence in the business value by agreeing to a conversion price at a substantial premium to the current share price while benefitting from interest payments in the interim. These instruments reduced dilution for the company, but in more recent years there are firms who have become much more ‘creative’ with shares issued at discounts. Not all CLNs are equal, and we must wait to see what Bidstack can negotiate.
But back to the valuation. The fact that the company has an agreement with Electronic Arts (“EA”), one of the world’s best known and most successful AAA games publishers, is a matter of public record. The NFL (National Football League) knows a thing or two about sponsorship and making money. One of their most storied franchises, the Washington Commanders, has just signed a partnership agreement and there may well be 31 more to come. It’s a truism of advertising that ad dollars follow eyeballs, and no form of entertainment globally has more eyeballs than gaming.
Speaking of the NFL, would you be surprised to hear that the League of Legends finals attracted more viewers (137m) than the Super Bowl 2023 (113m), the biggest annual sports event in the world? From newspapers, through TV to digital advertising and connected TV, once the standards are in place and the format adopted, the dollars flow exponentially. This is particularly true where programmatic infrastructure is in place allowing for almost limitless scale. You just need to look at The Trade Desk for evidence.
Anzu, Bidstack’s closest peer, is in the same market, subject to the same demand drivers and adoption curve, are at the same stage of concept proof, has similar revenues (we believe) and also needed funding. They have just raised $48m at a rumoured $200m valuation. Bidstack’s market cap? c.£10m
Bidstack has c.1,300m shares outstanding. Even if the share count is increased by 50% and they issue a further 650m shares (we hope not), the $200m Anzu valuation implies a share price for Bidstack of c.8p, 10x the current 0.8p. There doesn’t appear to be a rational argument that Bidstack is worth just 10% the value of Anzu.
What is going on to drive this apparent gulf in valuation? We don’t go by what investors are doing and focus on our own research, but let’s have a look at some of the Anzu investors. Emmis Corporation, Paypal Ventures, Bandai Namco Entertainment, Sony, WPP, NBCUniversal and Axel Springer. Some names you have probably heard of. They could all be described as rational investors.
Anzu is private and can present its business plan in detail while being, to a certain extent, in control of its valuation. They were able to show investors what was clearly a credible plan to reach significant levels of profitability. With such a compelling investment case they were likely able to tell investors that they had a lot of interest and if they wanted to participate the valuation was (rumoured to be) $200m.
Bidstack is public and we have made no excuses for the board in allowing the current valuation level to manifest itself, but at this point many strategic and institutional investors are restricted from the size of companies they can invest in and are subject to ownership limits that restrict how much they can invest. Attractive funding options are, therefore, more difficult to negotiate at these valuation levels. The Bidstack valuation is reflective of the narrative. With a strong narrative, the Anzu valuation appears reflective of the fundamentals.
Our understanding is that the smaller competitors are falling behind Bidstack and Anzu, with the two of them set to dominate the potential multi-billion market. There is plenty of valuation to go around. There are several things the company can do to improve the share price, but what can shareholders do about it? We’ll come to that later.
Let’s move to Avacta.
I’m not a specialist healthcare investor but I’ve read enough RNS announcements over the years to understand that the Avacta AVA6000 trial results appear extraordinary. We’ll put aside the value of the profitable diagnostics business, AVA3996, the preCISION platform, the Affimer platform, the joint ventures with global partners and focus purely on the lead therapeutic candidate AVA6000. Investors all know of this modified form of doxorubicin that is targeted at tumours to provide chemotherapy without the side effects.
The clinical trials to date have shown that:
- AVA6000 leaves multiples of the required therapeutic levels of doxorubicin in tumours.
- Side effects have been so greatly reduced that a maximum tolerated dose has not yet been found.
- Several patients remain on trial in different dose cohorts and continue to receive AVA6000 as their disease has not progressed, despite doxorubicin not being the standard of care for their tumour types.
Despite these very clear indicators of success, there remains a narrative that the doxorubicin delivered by AVA6000 isn’t ‘real’ doxorubicin, won’t have the same therapeutic effect, has delayed trials that are burning cash and the company needs additional funding imminently. Putting aside the fact that additional funding is a known and not a sinister unknown, I went to the AGM (one of the best and most enjoyable I have ever been to) to clear up some of these issues directly. AGMs are the forum for any shareholder to directly question company management and directors.
The Avacta CEO has now publicly stated, to camera:
- AVA6000 leaves pure doxorubicin in tumours.
- There is, therefore, no medical, biological or chemical reason why doxorubicin cleaved from AVA6000 will not behave in exactly the same way and have the same therapeutic effect.
- There is a very high, and at least 50% chance that AVA6000 will successfully complete clinical trials and replace doxorubicin as the standard of care.
- AVA6000 has the potential to become a $1bn annual revenue drug.
- The company is funded into H2 24 and there are upcoming licensing opportunities and milestone payments before then that can extend that runway and increase the valuation.
And yet the market appears to ignore these statements and allows the funding narrative and fear of trial failure to drive the share price down. Is this rational? Let’s look at some numbers.
Doxorubicin had annual sales in 2022 of c.$1.4bn. Given AVA6000’s safety profile and potential for greater efficacy, it could not only become the standard of care ‘overnight’ and take significant market share, but it can also greatly expand the market. It would also be on patent rather than generic, leading to much higher pricing. To be conservative, let’s stay with the CEO’s belief that $1bn revenues p.a. are realistic. We can then calculate:
- $1bn/c.£800m revenues at peak sales post successful trials in say, 6 years’ time,
- Apply a conservative 6x multiplier to account for cost of sales (manufacturing, distribution, potential partner share), remaining patent life i.e. this would be 12x profit at 50% margin.
- Discount the 6 x £800m = £4.8bn by the 6-year discount factor (assuming a 15% equity discount rate) of 0.43.
- The discounted present value = c.£2.1bn (£4.8bn x 0.43), equivalent to a share price of £7.4 which is 8x the current c.90p.
- Even applying a 50% chance of success and acknowledging the funding required to reach that point, that’s a share price of £3.7
- If AVA3996 is similarly successful at trial, we understand its market potential is even greater as the first drug to target solid tumours effectively.
What do we conclude?
The Anzu valuation is in the books and there is no evidence (to my knowledge) to suggest that Bidstack isn’t at least keeping pace operationally if not drawing ahead. The trial results for Avacta are, in the word of the CEO, “remarkable” and the value of successful chemo drugs is there to be found in abundance. The end goals for Bidstack and Avacta haven’t changed, only the short-term timing of achieving milestones. Isn’t it a truism that everything always takes longer than you expect?
Given the enormous potential upsides, it is difficult to produce any rational risk/reward equation (incorporating any reasonable probability of success) that doesn’t produce share prices that are multiples of the current share prices, even with downside cases of zero. A view that either business will ultimately fail is perfectly valid and that seems to be the narrative currently driving the share prices, but as shown, I don’t believe it reflects a reasonable risk/reward calculation.
Sometimes the eventual outcome will come down on the risk side of the equation – that is the mathematical certainty of probabilities greater than zero. However, if you always acknowledge the risk is there with an appropriate probability then you can make rationally ‘correct’ decisions even though the eventual outcome ‘proves’ you were wrong.
These are clearly not the only cases of demonstrable undervaluation. Long-term shareholders bemoan their shares are hugely undervalued and are being manipulated by short-term traders, but then sell shares at the low prices to provide exactly the liquidity that allows the share price to decline. The market is a supply and demand mechanism. If the supply of cheap shares isn’t there, share prices can only go one way.
As an investor, rather than a trader, if you had enough conviction in the companies to buy the shares in the first place, why don’t you have the conviction to hold them now if the factual evidence has improved the outlook and it is just the share price that has changed? Where the outlook has apparently deteriorated, was it due to underlying business dynamics or was it poor communication and ineffective management / governance? If the latter, what did you do about it?
Is this where investors are failing companies?
- Selling shares based on narrative alone without engaging to clarify fact from fiction.
- Allowing ineffective managements and boards to prosper while they destroy shareholder value.
- Not supporting companies with constructive feedback and expert insights.
Effective engagement with companies you have invested in can unlock shareholder value and can be more prosperous in the long-term than immediately selling for the next best opportunity in the short-term.
What is to be done?
Certain headlines drive selling because that’s what conventional wisdom dictates.
- People read that inflation is going up and you must, therefore, sell equities despite equities being the only asset class returns proven to at least keep pace with recent levels of inflation.
- People read CLN, someone yells death spiral finance, and share prices go down without the thought of reviewing the deal terms in detail.
- Funding requirements are generally apparent some way in advance and the rational reaction of investors should be to hold their shares and vocally support company progress to ensure the share price (or conversion price) increases so that dilution is minimised, and new investors pay for the progress that has already been achieved. Instead, conventional wisdom is to panic sell shares in fear of dilution and the prophecy self-fulfils allowing new investors to capture, at a discount, the value you took the risk for.
This isn’t an argument to blindly support companies you’ve invested in until they go to zero if the evidence suggests failure is on the way. It is mathematical fact that probabilities change as new evidence presents itself. There is, however, a huge difference between factual evidence and narrative. The rewards for finding and holding multi-baggers falls to those that can accurately discern the difference and ignore the noise. Support and protect your portfolio where the operational performance merits it. Others are happy to buy it off you cheaply or simply make a turn on your indecision.
Listed companies obviously can’t make direct statements about the value of their share prices and even short-term financial guidance needs to be carefully considered. However, that doesn’t stop them from stating medium term goals with a roadmap for achieving them and certainly doesn’t stop them from highlighting comparative valuations or scenario analysis. But there is only so much they can do and while many companies don’t do enough to give the relevant information, it isn’t their job to set share prices.
It is for investors to put a value on share prices given the information they have available. That’s what the markets provide a mechanism for. But the market isn’t all about fundamental valuations. It is about sentiment and emotion. It is about different investing and trading strategies with different timeframes for success and different return requirements. With market sentiment broadly so poor and many valuations making little sense we understand the need for traders to profit from whatever opportunities the current narratives serve up. Fair enough – that’s their strategy and it’s no less valid than any other. But you don’t have to play someone else’s game. You can engage.
The value of engagement
As investors, we must recognise that companies are primarily focused on driving the business forward while we are primarily focused on the share price. Managements are experts on their businesses but not necessarily experts in investor communications and valuations. In the same way that we can’t read their minds for all the material information they know but can’t share, they can’t read ours for every communication we want to see and in what form we want to see it.
Where the issue is narrative, the answer is collaborative engagement and effective communication to build mutual trust. Where the issue is no communication, a lack of expertise or worse, the answer is proactive engagement to bring about change.
At Bidstack we believed there was an issue that required change, proactive engagement has effected that change and the channel for collaborative engagement is now open. While more change may be required, the path is now clear for the company to prove its intent to take control of the narrative. What if their narrative changed?
- Current narrative: No operational progress is visibly being made, dilution is coming from CLN funding and the company doesn’t care about shareholder value.
- What the narrative could be: The company is leading the field in a potential multi-billion market, has agreements with key partners, is worth at least what Anzu is worth and new investors should be paying a premium price to participate in the upside.
At Avacta we believed the narrative wasn’t cutting through and tried to help publicly articulate the key facts. Avacta acknowledged that their message can get lost in the fascinating science and aim to hone their narrative to the investment community. What if their narrative changed?
- Current narrative: Trial delays will lead to more dilutive funding and it’s unclear that the technology even works as the science and trial data are difficult to understand.
- What the narrative could be: The trial data proves our technology works and is so good that we are taking a short period of extra time to increase its standalone and licensing value, which is likely to be in the many billions of pounds.
The narrative for these companies can easily be changed by both the companies and shareholders. People buy stories. These could be two best sellers.
Engagement at MHM
Alongside our compelling, actionable investment ideas, our platform has evolved to lead shareholder engagement for positive change and we are actively looking for Engagement Members to join. Collectively we can unlock shareholder value that specialist fund managers charge ‘2 & 20’ fees for. Don’t let others capture your value at a discount.
You can find more details on our proposition here:
MHM-Engagement-Proposition.pdf (mhmembers.com)
In addition to the management discussions we already undertake as part of our idea due diligence, we are aiming to produce exclusive video content for members and will be inviting both Avacta and Bidstack CEOs to participate in conversations focused purely on value drivers. Obviously, this content will need a catchy series title and with these valuations currently dormant but set to erupt, we can’t get The Value Volcano out of our head. Please, please someone send us some better ideas!
Join us at: https://mhmembers.com/
None of the above is financial advice. Please see the MHM site terms and conditions:
