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Notes and musings from a Value investor

Taking the medicine

31 January 2017
Author: Alastair MundyHead of Value

We recently met with the management of one of our poorest investments. The company is now what can perhaps euphemistically call a ‘recovery’ stock and poor trading has necessitated a change in strategy. The management explained, as they tend to in these situations that the nettle had now been grasped, changes were afoot, lessons learnt and consequently they were cautiously optimistic for the future.

The clichés were flying across the table, but one point that interested us was whether the management were following the optimal path to execute a turnaround. We enquired if they would behave any differently if the company was not listed on the stock market. The answer, whilst not surprising, was however a touch depressing. They admitted that under different ownership they would very likely act with greater urgency. Their argument, although not verbalised, was that such dramatic change would result either in short-term performance so bad as to jeopardise their jobs or to attract the unwanted attention of predators eager to secure the company at a low price.

It is possible to have some sympathy with the management’s view except that they appear to have reached their decision on execution speed without consulting shareholders. It seems that management has justified to themselves that the risk of a slow painful death is preferable to the risk of a particularly ugly, say, six months of extreme restructuring. Given shareholders usually invested in such deep value plays typically have strong stomachs, management in this type of situation could be rather more alert to their desires.

But not all management teams react in this way when their business reaches a tipping point. Sports Direct has experienced a dreadful year. Much has been made of the unacceptable working conditions in the company’s main warehouse and of the company’s corporate governance in general, whilst trading in the company’s stores has deteriorated quite significantly and the company’s major brand suppliers such as Nike and Adidas have demanded that the Sports Direct stores should be smarter if they are to supply the company with their most popular products. Mike Ashley, the company’s founder, majority owner and chief executive has responded with almost manic enthusiasm. He has accepted that much needs to be done and has responded by launching a freehold property buying frenzy, committing to refurbishing the stores and withdrawing from the pile it high, sell it cheap policy that has previously served the company well. Ashley, is quite happy to admit that he has no idea if this strategy will prove successful, but feels he has no choice and that speed is of the essence.

Perhaps it is however telling that Sports Direct is very much Ashley’s baby (something for which he is often criticised). As owner of about half of the company he has plenty of skin in the game and therefore is doing, we must assume, what is necessary to protect (and grow?) his investment. Whilst shareholders may be concerned that he openly questions the new strategy, there can be little doubt that he is totally committed to it.

In Shoe Dog, Phil Knight, the founder of Nike, details the story of the company’s success. Parts of the book are so ridiculous (the company seems close to bankruptcy more than once) it is hard to believe it is a true tale. Bill Gates summed the story up perfectly, ‘Shoe Dog…is a refreshingly honest reminder of what the path to success really looks like. It’s a messy, perilous, and chaotic journey riddled with mistakes, endless struggles, and sacrifice.’ Shareholders must appreciate that smooth journeys are not always preferable and that sometimes companies need to undergo significant change, whatever the short-term consequences.

Alastair Mundy
Alastair Mundy Head of Value

Important information

This communication is provided for general information only should not be construed as advice.

All the information in is believed to be reliable but may be inaccurate or incomplete. The views are those of the contributor at the time of publication and do not necessary reflect those of Investec Asset Management.

Any opinions stated are honestly held but are not guaranteed and should not be relied upon.

All rights reserved. Issued by Investec Asset Management, issued January 2017.

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