Undervalue?, page-66

"But what are you questioning exactly? You mean they spent too little (close to zero) on software development, since there is no cost capitalised or expensed? That is not true and if it is true is it a good thing or bad? Well, sounds not that bad to me."

You've missed the point.

What I am questioning - well, not questioning, but articulating as I see it - is a fundamental business risk.

When assessing an investment, and the risks to that investment, the top 5 risks I assess are as follows:

1. Self-Sustaining Commercialisation/Capital Adequacy

2. Excessive Customer Concentration

3. Critical Supplier Dependency

4. Scope for Product/Service Obsolescence

5. Quality of Financial Statements


SWF passes muster in terms of Points 1 (it has a product which is already selling, so no proof of concept required and it is clearly adequately capitalised) as well as Point 2 (while the activity of its customer base is likely to be seasonal depending on market conditions, SWF's customer base is highly granular and sure to be quite sticky.)

But where SWF falls down for me in terms of being investment grade is at Point 3. Too much of the company's business-critical back end has been outsourced to third-parties which, besides the business continuity risk, presents business economic risk in terms of asymmetric bargaining power in relation to critical inputs to the business.

The world of business and finance is a very fluid one, and a lot can happen over time to important commercial counter-parties on which a company depends.

So that's why, in this case, I'm concerned that too much business-critical IP has been outsourced to others.

Don't get me wrong - I'm not dooming the business to catastrophic failure; the structural risks that I see might never materialise in terms of permanently impairing the business, and the company might go on to reach great heights of prosperity.

That happens to a great many companies which I look at, but choose to not own.

But I'm not in the business of snaring every stock that goes up in value; I'm in the business of investing on the basis of trying to avoid permanent loss of my capital.

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