Friday, October 14, 2016

Why I sold a position that was up more than 300%

I recently parted with a business that generated substantial wealth creation for me. Let me explain why. 
I’m typically loath to separate myself from a business that’s demonstrated a track record of growing long-term wealth. However just recently I sold a position that had grown by more than 350%. Surprisingly this was a relatively easy decision to make. Of course it wasn’t a decision that I took lightly.
As I’ve explained in the past strong long-term returns are typically driven by holding a select few performers that account for the substantial portion of a portfolio’s long-term return. You have to let your winners thrive and let your losers wither.
In this context Big Air Limited which was a small position that I initiated several years ago that had provided share price appreciation of close to 350%. I bought the stock when it was trading at $0.28   and just recently sold the position at just over a dollar.

So the natural question is why did I sell something that was such a long term winner? Fact of the matter is, I started to get a little bit nervous about the long-term outlook for big air. The business had been doing a substantial number of roll ups and tuck in acquisitions over the last couple of years, far more than to my liking. It was also becoming evident that core organic growth within the business had started to crawl along at a rather modest rate.
For a small-cap company such a dramatic deceleration in the growth rate is typically the kiss of death. This goes back to my earlier point of view about how hard it is to pick small-cap winners. Truly successful businesses get acquired well before they’re able to deliver massive shareholders windfalls, while other small caps struggle to shift beyond second-gear into the high rates of growth that are needed to propel them into truly large businesses.
My philosophy towards early-stage businesses has also shifted away from one focused on small cap growth sake towards a predisposition to mid-cap companies that have developed good solid network effects as well as some element of customer stickiness.
I want a business that have a visible pathway to continued growth, which comes from solving a customer pain point in way that becomes an integral part of a customers routine. This goes for both enterprise and consumer plays.
It was becoming increasingly clear to me that Big Air had neither of those things. I was fairly confident however that Big Air would eventually be acquired.
That’s because telecom (which was the space in which Big Air operated) is ultimately an industry that’s all about scale. The small Telcos with network assets or a viable customer base will simply get rolled up by larger competitors that will then be able to realize higher margins on those network assets or cross sell a variety of products to an expanded customer base.
That was exactly the fate that M2 telecommunications met with. Unsurprisingly Big Air also found itself the recipient of a takeover offer.
Now I’m ultimately interested in businesses for their longer-term potential and not simply for the prospect of a near-term takeover. True wealth is created by holding a long time compounder for many years rather than choosing to sell out of business within the space of 2 to 3 years.
Unfortunately high-quality early-stage businesses typically find themselves the recipient of takeover offers early in their lives. In this case such an offer came in the form of a take over bid from an early-stage, unprofitable high-growth business whose business model I didn’t actually understand.
That relative lack of profitability of the acquiring business plus a suspect business model lead me to the inevitable conclusion of selling my position once the offer materialized.  While it may have been a far more tax efficient play to hold onto my shares and try my hand with the acquiring business, I didn’t have enough confidence and conviction that my capital would be well preserved in the new company.
Hence my association with Big Air Limited, one of my more stellar early-stage businesses, ultimately came to a premature end. That’s how I ended up selling a position that returned close to 350%

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