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Lessons for Value Investors in the Nu Horizons Buyout

September 21, 2010 | About:
Saj Karsan

Saj Karsan

20 followers
Six months ago, we discussed Nu Horizons (NUHC) as a potential value investment. Yesterday, it rose 102% after receiving a buyout offer with a hefty premium. Therefore, today the stock moves off of the Stock Ideas page and onto the Value In Action page. Here are four lessons one can take from this type of investment that reinforce "value investing" principles.

1) Basing a company's value on its current earnings is a poor idea

Current earnings fluctuate. Particularly during a recession, current earnings are not a good gauge of what a company can earn, or what a company is worth. Instead, investors should look at normalized earnings as well as assets (particularly liquid ones) in forming a valuation opinion.

2) Identifiable catalysts are not necessary

There was no reason to believe that Nu Horizons would be bought out. If there were, the stock probably would not have traded at such a large discount to its assets. When investors buy businesses for much less than what they are worth, the odds are very much on their side when it comes to receiving a favourable return. Subjectively applying catalyst values could result in missed opportunities.

3) Book value matters

Many investors believe book values to be completely irrelevant. Value investors know that just isn't correct. In buyout cases such as this one, where return on capital has been around or below the cost of capital, the transaction price is often quite close to book value. This is because it would take the acquirer around that much money to build up the assets that they seek internally. But they do save time by making an acquisition, and they do acquire intangibles such as customer/supplier relationships and know-how, which is why this type of acquisition often takes place at a premium to book value.

4) A variable cost structure helps

The recession and the ensuing loss of a supplier took a bite out of Nu Horizons' revenues. But because the company is not burdened with a high percentage of fixed costs, the company was able to adjust and return to profitability relatively quickly. Undoubtedly, this helped it secure an asking price that was above, rather than below, book value.

Disclosure: None


Saj Karsan

http://www.barelkarsan.com

About the author:

Saj Karsan
Saj Karsan founded an investment and research firm that is based on the principles of value investing. He has an MBA from the Richard Ivey School of Business, and an undergraduate engineering degree from McGill University.

Rating: 4.5/5 (2 votes)

Comments

graemew
Graemew - 3 years ago


Well, another way to look at it, is that if it hadn't been bought out it could have gone bust. Looking at the company´s very poor earnings record it looks like the management could have run the company to bankruptcy...that was a risk...and so I would never have bought a stock like this, even if it was selling at half book value as it was. If I was sufficiently financially competent to really understand the finances of this company then it would be a different matter...I admit that this kind of company is outside of my circle of competence. I could never imagine the present day Warren Buffett buying a stock like this, even if Graham had done so years ago.
batbeer2
Batbeer2 premium member - 3 years ago
@ Saj

Good work !

@ Graemew

I Agree. I looked at Nu Horizons and concluded that this was not something I would feel comfortable holding for 10 years...... Cheap, yes; good no.

For me, if I wouldn't want to buy the last share (at that price) then I will not buy the first.

Having said that, buying a bunch of NCAVs like Nu Horizons is a very effective and safe way to grow your wealth. So.... good work Saj !
Adib Motiwala
Adib Motiwala - 3 years ago
Good article. I just read another by Greg today on GuruFocus which gives an example of Buffett saying dont put too much emphasis on book value. He was referring to the textile mills of Berkshire..
wje3
Wje3 - 3 years ago
Hi Everyone;

This is my first post to the forum.

I bought NUHC last year as an NCAV liquidation bargain, thanks to gurufocus.com(thank you gurufocus.com) and was obviously pleased with the buyout.

My question pertains to insider and institutional ownership levels:

Insiders: Is there a "rule of thumb" where a certain percentage ownership by insiders is worrisome such that a buyout as with NUHC couldn't occur? I've always worried that at a certain level of ownership, the insiders, maybe a family, could just use the company as their personal piggybank and ride it into the ground. I imagine once you get around the 50% level of insider ownership,red flags would arise.NUHC only had a 15% insider ownership level.

Institutions: Same question as above only with Institutions this time. Any ownership levels that raise alarms?

Thanks in advance for your help.

Bill

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