This is part 5 in a series called “Beyond Buffettology”, penned by Portfolio Manager George Kurian, CFA.
You can read part 1, part 2, part 3, part 4 here.
Athenians: … right, as the world goes, is only in question between equals in power, while the strong do what they can and the weak suffer what they must.”
Melians: … you should not destroy what is our common protection, namely the privilege of being allowed in danger to invoke what is fair and right, and even to profit by arguments not strictly valid if they can be persuasive.
–Melian Dialogue, History of the Peloponnesian War by Thucydides.
‘Fair and right’ arguments did not save the Melians. As Thucydides noted, Athenians executed the Melian men and enslaved the women and children. How does the failure of ‘fair and right’ and the triumph of self-interest apply to us more than two thousand years later in the stock markets?
In the last three episodes, we looked at how self-interest-driven Politics creates and destroys value in the stock markets. In the last episode, we saw how negative corporate politics destroys shareholder value due to internal reasons viz. failure of checks and balances of power structures. In this last episode on Politics, we look at how shareholder value could be created or destroyed due to an earthy external reason – Corporeal self-interest.
Corporeal politics reared its head in the takeover saga of Origin (ASX:ORG) by the Brookfield (NYSE:BN) led Consortium. The Consortium originally proposed an A$7.95 per share takeover of Origin, a large octopussian utility in Australia. The takeover price after several revisions was finally upgraded to about A$9.5. This was at the upper end of independent valuation between A$8.45 to A$9.48. Enter Australian Super, Origin’s largest shareholder, who thought that the offer was ‘substantially below Origin’s long-term value’, and without whose support Consortium was unlikely to get the required 75% of total votes to consummate the deal. In the end, the deal failed with 68.92% votes in favour and 31.08% against. The Origin board recommended the deal, and most shareholders voted for the deal, but the deal still fell flat at the Mergers & Acquisitions altar!
The crux is that Australian Super did not reveal how/where it saw higher value in Origin. The most likely area is the Origin’s stake in UK-based Octopus Energy, which is in the early stage of its high-growth future. The important point is that the takeover was blocked for all shareholders based on one shareholder’s value perception based on private assumptions. As key assumptions have wide-ranging valuation possibilities, simply from the diverging beliefs on growth and its duration, politics mixed with hope could easily become ‘the father of any valuation’. ‘Hitch your wagon to a star’, the American philosopher Ralph Waldo Emerson famously exhorted us. However, here we have a situation where minority shareholders are forced to hitch their wagons to the majority shareholder, a forced marriage where the minority shareholders would swim or sink depending on just one thing – whether the forecasting capability of the armchair majority shareholder could be better than that of the executive management!
All business schools teach that the stock value is the present value of future cash flow expectations, but none teach that it could also be the present value of major shareholders’ ‘secret’ cash flow expectations. Yogi Berra, the famous American baseball catcher, noted that ‘In theory, there is no difference between theory and practice. In practice there is.” In stock markets, Corporeal politics is often that difference.
The takeover drama at Liontown (ASX: LTR) showed us another aspect of Corporeal Politics. Liontown first received a takeover offer from Albemarle (NYSE: ALB), back in October 2022. However, this was not publicly disclosed, and after several negotiations, Liontown publicly announced the takeover bid for $2.5 per share on March 28th, 2023, when the stock was trading at $1.53. However, that offer was deemed unattractive by the Liontown board, and after protracted negotiations, Albemarle succeeded in winning the board by offering $3 per share. At $3 per share, the deal was valued at about $6.6bn, and that would have been nearly 100% upside for the shareholders, and a billion-dollar payday for the Liontown chairman who owned 15% of the firm. However, that was not to be! Hancock Prospecting, the private vehicle of Australia’s richest person Gina Rinehart, had quietly built up about 19.9% stake in Liontown. The true objective of Hancock is still shrouded in mystery, but indications were that it wanted a board seat and mining contracts from Liontown. However, Albemarle, tired of long negotiations and ever-growing concerns over the falling lithium prices, finally withdrew its offer for Liontown. The stock, as of this writing nearly a year later, is at $0.6. That is an 80% drop from the final takeover offer. So, the minority shareholders lost out because their interest (sale at a silly price to a blue-sky believer) was not aligned with the major shareholder Hancock, whose focus was on the cashflows from the multi-year mining contracts.
While negative Corporate Politics could be curbed with appropriate structures and independent monitoring, there is no cure for Corporeal Politics. This is because the minority shareholder payout structures in the stock markets are not based on ethics but power, with access to money, muscle and media determining the winners provided the law is not breached.
The often-cited raison d'etre of Capitalism is Adam Smith’s Invisible Hand argument. This is the idea that individuals in their pursuit of unbridled self-interest would ensure the common good, i.e. my pleasure becomes ours.
“It is not from the benevolence of the butcher, the brewer, or the baker, that we can expect our dinner, but from their regard to their own interest” – Adam Smith, The Wealth of Nations.
Here Smith assumed that an individual butcher, brewer or baker is just a commodity service provider who is easily interchangeable with other butchers, brewers and bakers respectively. However, what if there is only one butcher in town? What if all the brewers in the town are colluding? What if one baker has captured most of the wheat supplies? In these scenarios, one could see that the benign ‘invisible hand’ morphs into a ‘whipping hand’ on consumers.
Similarly, in the stock markets, the invisible hand breaks down when there is power concentration among some shareholders. We saw that in the Origin takeover, the minority shareholders’ interest came up against the might of the largest super fund in the country. In the Liontown situation, it came up against the interest of the richest person in Australia. In both situations, minority shareholders had no recourse but to meekly submit and pray that the stock market Godzillas do not trample the Lilliputian minority shareholders. Hence, in addition to the traditional company analysis, minority investors should also focus on the company’s static and dynamic political structures to better understand and anticipate the valuation scenarios. All this calls for a multi-disciplinary approach to investing beyond the Grahamian financial statement focus, Fisherian growth approach, and Buffettian numbers plus growth philosophy.
In the next episode, we will discuss one such approach, Reflexivity, originally formulated by the investing legend George Soros, and how this could be applied to the ASX.
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