Turnaround Cases: Premier Exhibitions Part 5 ($PRXI)
A new scientific truth does not triumph by convincing its opponents and making them see the light, but rather because its opponents eventually die, and a new generation grows up that is familiar with it – Max Planck
Science advances one funeral at a time – the shorter version
In the last part we ended our review of the turnaround plan and started tackling why usually institutional investors avoid turnarounds. There are several other reasons that deter institutional investors:
- Headline headaches: the early stages of a turnaround are only bad news. New management may even exacerbate this on purpose trying to get all the bad news behind them early on. Including impairments, write downs, and restructuring costs.
- Window dressing: imagine yourself explaining every quarter the reasons why you own Eastman Kodak to your investors. Most fund managers are in the asset gathering business where their investors can leave at any moment, so it is critical to build an aura of infallibility. It is much easier to just avoid it or sell it.
- Information gaps: as we mentioned, management will “go dark for a bit” and many times the company can even be delinquent on their financials
What about Wall Street analysts? I do not want to be too harsh on them but for turnaround investing they can be worse than useless. We are all familiar with the bull bias in the profession, for example it is a well known fact that buy recommendations are disproportionally higher to sell recommendations. Now imagine an analyst reaction with a disappointing stock they have recommended. Even more, from a company that is not going to bring much investment banking business for a while.
Whose fault is this disappointment? The human reaction is to blame the company and its management. Not doing so is to admit that they were in fault with their rosy estimates. Add the psychological need for consistency and the result is the perpetuation of their bad perception of the company even when the turnaround is in full swing. Only when a new generation of analysts comes along it becomes easier to smell the coffee and without the analyst guidance the non entrepreneurial retail investor is lost.
So let’s imagine how the stock of a company in a turnaround develops over time. Premier has still lot to prove before we can brand it a successful turnaround. But I will still use it as an example for familiarity’s sake.
First, there is usually a jump just because the company is ridiculously cheap. For example, after Premier’s new management took control in February price continued its collapse. Part of it was that the market as a whole was skydiving in February but also it reflected the uncertainty of Premier’s situation. Then at the end of March there is a reversal that almost doubles the price. As you have read in other posts, I do not like to invest in this stage given that the company is still burning cash but I imagine the temptation for a Graham type investor that feels a margin of safety in the value of the assets.
Next, if the company finds ways to reduce the bleeding there is usually a Never Never Land period. All news is bad but fundamentals are improving. Neither price nor volume is going anywhere because institutional investors are simply not interested. Every once in a while there might be a jump like in mid April, when Premier received a not very convincing buyout offer, but things soon return to a range. This period can extend for several months if the company is doing OK. If it is not doing OK, well we know how that ends.
This is the period where we can make a difference, looking for every signal of how things are going and making sure that when we finally invest the turnaround has a high probability of success. I hope that through Premier’s example you get the importance for a disciplined follow up, a proactive search for info, and the conviction for a concentrated bet when the stars align.
Finally, things start moving again. That usually means that the turnaround is starting to pick up momentum and its potential is becoming clear. That brings us to our next rule for successful turnaround investing:
RULE #3 A TURNAROUND IS ITS OWN CATALYST
Fundamentals have improved sufficiently, we will see what that means in the next post, so it is attracting early buyers like you and me. Therefore price starts moving but we might still be disappointed because institutional investors are still not showing interest. However, another buyer, most critical and convincing, usually appears around here:
RULE #4 INSIDERS WILL RING A BELL
We mentioned incentives when we discussed the Wall Street analyst role. Insiders also have incentives and a privileged position to detect a bargain if there is one. Do you see that volume jump in early July? That is Mark Sellers buying one million shares that is close to two percent of the outstanding. Several directors and Chris Davino bought smaller positions too. Then in September 21st the company announced a one million shares buyback program. These two combined, insider buying and share buybacks, are a very powerful buy signal and it preludes the re-engagement of the institutional investor with a rapid rise of price and volume.
However, as we have learned over the last year, insider buying and share buybacks can have other motivators. Insider buying can be the result of CEOs trying to fake confidence when they depend on external financing. Share buybacks can serve to sustain prices for the exercise of stock options. It does not seem to be the case for Premier but it is still important that the fundamentals are doing well too. And that is what we are going to review in the next part. There is not much left, please have some patience!