# Small cap investing, majority control and small shareholders



## cuttlefish (26 June 2006)

Hi,

I'm primarily an investor so looking at this issue from an investment viewpoint (i.e buying part ownership/interest in a business not buying a price movement).

One issue that I've come across is in businesses that have fairly low percentage of free liquidity e.g. 70%+ of ownership is tied up in a majority shareholder. For minority shareholders I believe that often when a business like this begins to show its true potential, minority shareholders often miss out on realising the full value. I'm wondering if this is something else others have come across and are conscious of as an issue.

Examples of the sort of thing I'm talking about could be:

* As the company starts to generate decent profits, funds, institutions or other strategic investors get on board via capital raisings done by the company issuing shares at market price. This saves them from having to buy a strategic stake on market so to some extent removes a potential source of upward pressure on the price. To me this disadvantages small shareholders that have had to patiently accumulate a holding at market prices as stock becomes available. I believe the reason the majority shareholder would approve a capital raising such as this is for the credibilty obtained by having a significant strategic investor take a stake (and sometimes because the company can benefit from the capital though I've seen this sort of thing happen in companies that have so much cash they already don't know what to do with it).

* The other one that worries me the most and is quite a common one is that the major shareholder sells out too early to another company, thus forcing the smaller shareholders to have to go along as well - often meaning a good value business is sold too cheaply (or more cheaply than the smaller shareholders would have agreed to).

* A further one that worries me is siphoning of profits into related businesses rather than returning them to shareholders - not sure how much this goes on and I'm also not sure what legal protection there is for this sort of stuff (I know it needs to be disclosed - but that doesn't mean its not allowed to be done does it?).  For example a company that spends a lot of money on marketing with another company that is related to the primary shareholder, rather than returning that money as profits.

* Another one is just the majority shareholder doing some type of mop-up operation themselves as value starts to come into the business and privatising it - again forcing smaller shareholders to give up a shareholding in a good business at a price they don't believe values it properly.

I'm sure there's other things - and if anyone can think of others I'd be curious to hear them.

Just wondering if other people have come across these sorts of issues and how much it impacts a decision to invest in a small cap. 

I guess the same issues apply with large capitalisation stocks as well, but typically the controlling interest isn't as significant (if there is one) so there are other large shareholders that even the balance out, also the higher profile means things that cause a significant disadvantage to smaller shareholders get media attention.

any input appreciated.


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## ghotib (27 June 2006)

Interesting situations. Before purchase you can see the presence of absence of substantial shareholders and take them into account in your buy / don't buy choice. As holders, I guess we should be keeping an eye on the share register as well as the price, but beyond checking all company notices I can't say I do it.

I guess this comes down to confidence in the board and in management. Are the directors representing all shareholders or just collecting fees? Is management running the company with an eye to its long-term future or its short-term share price? I think these are difficult judgements to make - the best con artists have to be very believable people. It might be a bit easier for small companies because you might have a better chance of talking directly to decision makers and because the general meetings are small enough to eyeball them and have a bit of time with them. 

I've encountered another situation that's vaguely relevant to this topic. I bought into CAM at its IPO in Feb 2004, and was happy to see a fairly small register with no huge holdings. Price dropped well below NTA (still is) and by September 2005 one shareholder had accumulated just under 20%. That shareholder was National Exchange Pty Ltd, one of the investment vehicles of David Tweed. I was at the AGM he attended and at 4 of the 5 EGMs he requested, and I saw no evidence that he had the slightest interest in the long-term health of the company  

This case is a bit different to the ones you're posing because the not-quite-substantial shareholder is well known and widely loathed and because he has a snowball's chance in hell of doing favourable deals with the board. But I think it's possible that some trading in the shares for the last 12 months has been Tweed buying and selling among his own interests and I'm sure that his presence in the register is unsettling to other shareholders and distracting to management. Very educational though 

I intend to get around to joining the Oz Shareholders' Ass'n one of these years. Seems to me that's one avenue for additional information and for lobbying clout. Anyone have reason to agree with that?


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## cuttlefish (27 June 2006)

Even though its an unusual example, it's actually a good point and something I've seen sometimes with large cap stocks that are underperforming where the funds that have large shareholdings start to pressure the board to make decisions that are more short term focused rather than long term - often with success.  Examples that come to mind are companies divesting non-core assets even though they are good assets, or in mining divesting assets at the wrong time in a cycle. Also they can influence a decision to accept a takeover offer as well.  So I guess any company, large or small, has this issue.

I can see why murdoch issued two classes of shares in news   

As you say the reality is that confidence in the people running the business is a decision that needs to be made as part of the investment, though sometimes people can run a business well, just not sell it as well.


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## ghotib (27 June 2006)

cuttlefish said:
			
		

> Even though its an unusual example, it's actually a good point and something I've seen sometimes with large cap stocks that are underperforming where the funds that have large shareholdings start to pressure the board to make decisions that are more short term focused rather than long term - often with success.



Absolutely!! I actually see that as another reason to avoid large caps, including blue chips. Too many different goals among the shareholders. Though I might change my mind as my capital grows.

You know, I'm beginning to think I really am a Buffetologist at heart. I *like* business. Though I wouldn't hire me as an employee in one.


> As you say the reality is that confidence in the people running the business is a decision that needs to be made as part of the investment, though sometimes people can run a business well, just not sell it as well.



And over time people change, even if they don't physically leave. As the saying doesn't go, "The price of shareholding is eternal vigilance".


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