| Small & micro cap project 

13D filing is not an oral liquid antibiotic

by | Nov 15, 2019

13Ds do not have a shorter shelf-life

Oral liquid antibiotics have a short shelf life. As soon as the powdered form is added with water, the clock starts ticking. It should be consumed within a few days.

Many view 13D filings as similar to an oral liquid antibiotic, i.e. to generate alpha, one should invest within a few hours or days. This is bad logic – period.

Are there reasons for this delusional approach?

One of the reasons could be due to the way an activist’s performance is computed. It is common practice to compare the stock price on the “first filed 13D date” with the stock price on the “date of exit”. Since this data is widely reported in the media, many think they should invest with the same horizon to replicate the return.

The logical fallacy

As soon as an activist investor discloses an active stake, many start to predict the “probability of success”. If the probability is high, they invest. Otherwise they ignore it and move on.

The above approach has three “implicit assumptions”:

  1. One should invest alongside the activist to generate alpha.
  2. All activist situations are created equally.
  3. Activists with a low track record should be completely ignored.

1. One should invest alongside the activist to generate alpha.

Investors should invest immediately to generate alpha. This tops the list of fallacies in activist investing.

Investors who always do their homework before investing tend to shy away from this strategy – they simply do not like the idea of being “rushed” to invest.

Moreover, unless you are a 100% event-driven investor, reading a daily or weekly summary of activism may not be a part of your regular ritual. It may not be feasible. This is especially true when the entire team is working on an interesting stock idea. Unless the fund has an army of analysts and a dedicated idea screening team, it is simply not possible to screen (13D filings) on a regular basis.

2. All activist situations are created equally

Every activist filing is unique.

  • Agenda differs: Each activist investor’s rationale behind filing a 13D is different. It could be any of the following: CEO change, strategic alternatives, concerns over a controlling investor’s action, agitation against a merger or acquisition, and pushing for a board revamp etc.
  • Status of activism differs: Some 13D filers have “initiated” a stake, some might have secured a board seat, some have launched a proxy fight, some have lost a proxy fight, some may increase or decrease their stake,
  • Track records of filers differ: Some filers have a well-documented track record of success, while most filers have a very low or non-existent track record.

3. Activists with a low track record should be completely ignored

First things first; it is indeed correct to be concerned about the “first time”13D filer. We don’t know their true intention. At the same time, it doesn’t make sense to completely ignore them. One of the best ways to approach the 13D filings of newbie activist investors is to “wait and watch”. A few days back, I published an article where I argued that someone could generate ideas by tracking all the significant changes the company implements after the involvement of an activist. The rationale behind the screening is this – we can identify companies that are making changes, irrespective of the track record of the activist.

Fact to ponder

We can broadly classify 13D filers into two categories – those that file 13F and those that do not. The advantage with 13F filers is that we know their ownership status at the end of every quarter.

In our database, there are 190 13F filers that have filed a 13D in a stock. To be clear: we do not compile all the stocks in their portfolio. Instead we compile the stocks only if the 13F filer has filed a “significant” 13D. Out of that list, 13F filers increased their stakes in 45 stocks even though the fund did not file a 13D/A in the past year.

Let me explain: The 45 stocks satisfied the following three criteria:

(a) The 13F filer filed a 13D

(b) The 13F filer did not file any amended 13D filing in the past year, and

(c) increased their stake.

What is my point?

In the above 45 stocks, the activist investors found something interesting and increased their stake even though they were silent for more than one year after filing the first 13D filing. Isn’t it absurd to think that those who track 13Ds should restrict themselves to only new filings? It is like saying, I watch only newly-released movies.

Takeaway

  • Do not think that only recently filed 13Ds should be tracked.
  • Each 13D filing is unique in its own way.

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