There are several ways to conduct value investments – asset plays are one of them. Most of us try to value a company based on their ability to earn future profits. Discounting the future cash flows is one way of finding undervalued companies but there are many more. However there are special situations, where value investors can take advantage of – Asset plays.
What is an Asset Play Stock?
Asset plays are commonly referred to as stocks that have assets, whose value is not fully reflected on its price. Meaning that all of the company’s assets are worth more than the total market cap. The term asset play was coined by Peter Lynch, in its iconic book “One Up On Wall Street”. There he describes the arbitrage investment thesis behind asset play stocks.
Most often than not we find companies, with stakes in other companies that are worth much more than the market cap. Another scenario are companies whose assets are not fully reflected on its books, because they were accounted for at the price paid in the past.
The bottom line is there are different types of asset plays. Some of them are focused on real estate, investments, or cash and equivalents. Although value investors tend to look at the price-to-book to find such stocks. The price-to-book does not reflect the value of the company entirely. It is important to go through the company’s financials to be able to access which assets it owns that might not be fully reflected on its price. Due diligence is the key in this kind of investment opportunity. Being able to clearly identify the unappreciated assets, will allow you to have a better idea of what can happen so that value is unlocked.
Unlocking value in asset plays
Although asset plays can be very profitable investments, it might take time to materialize those returns. When you invest in an asset play stock, you have to wait until the market finally realizes the total value of the company’s assets are worth more than its market cap. Most of the time, management in asset play stocks is well aware that the company has a higher value than what it is trading at.
To try and reflect that value on the stock price they might try to spinoff some of its subsidiaries. This is a common solution for the problem, although it does not always work. A common scenario is that companies which are slowly growing, might have a subsidiary that is growing faster than the parent company. This is a perfect example of a great situation, where management tries to take advantage of spinoff.
Examples of asset plays
One of the most remarkable examples of this kind of situation was the Paypal spinoff. Ebay, which owned Paypal at the time, saw steady but slower growth on its marketplace. Paypal on the other hand was growing exponentially. Carl Ichan, a well seasoned activist investor noticed it. He proceeded to acquire a significant position in Ebay, so that he could have some presence on the board of directors. He pushed for the spin-off of Paypal, which would later become the bournemouth of online payments that we know today.
There are clear examples of asset plays in well known stocks. An example of that is Softbank, which owns a considerable stake in Alibaba, and well known companies. If we add the corresponding value of Softbank’s stakes in other companies and deduct it from the market cap. We realize that it is trading at a discount to its assets. On top of that we still have the underlying business in Japan, which is also a valuable asset. The efficient market hypothesis explains this discount, because it is unpredictable how the company will manage those assets.
Naspers, a South African based company was one of the early investors in Tencent. Nearly two decades have gone by, and that initial investment has turned out to be perhaps the best investment in the century. Naspers encountered some problems, despite all of the success of their Tencent investment. Its stake in the company was not fully recognized on its stock price. For a long time, Nasperes was selling for a lower market cap than the whole value of its Tencent stake. On top of that Naspers still has a very interesting underlying business, and several other investments. Naspers market cap has grown so much, that it was a key part of the South African exchange, where it trades. Naspers had such a weight on the index, that a significant move in price could affect the index’s performance tremendously.
In an effort to try to get the market to value the company closer to its real value. Management decided to create an entity, named Prosus, that would hold part of its Tencent stake, and it would trade separately from Naspers. Although the efforts were well intended, and the Naspers valuation increased, it still trades at a discount. Naspers and Prosus still remain asset play stocks.
Asset plays can be very profitable investments, even if they take some time to materialize. They offer enough margin of safety, due to the asset value being higher than the total market cap. Although this is one theme, within value investing – it can be combined with other ways of finding value stocks. You can play an asset that is also trading at a discount to its future earnings. An example of this is CK Hutchison, which we analyzed recently. CK Hutchison is still trading at a discount. It might take a while more before the market finally agrees with us on this one.
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