Apologies, page-36

You told us once that you were "sure you would make money out of MSB one day".
Please don't make me to trawl through threads to find this post; I know it is there.

Could you please tell us how you see that happening one day. This is not a provocation about your sentiment but a genuine question. As usual I would expect a deeply thought out response.


Antibody,

Thanks for what may be a sincere line of query, or it may be a sardonic one; I’m not sure, but I’ll answer it anyway.

Because my approach to investing can appear to be painstakingly passive, it is almost certain to not appeal to everyone.

I understand that.

But I have found that it works for me, for my personality, for my lifestyle, for my risk tolerance, and – most importantly – it has proven reliable through many equity market cycles, and has made me financially independent far sooner than I otherwise would have been.

In essence, for me investing in MSB – just like investing in any stock - is a two-step process:

STEP 1: Identifying the Upside Potential
STEP 2: Identifying the Downside Risk


STEP 1: UPSIDE POTENTIAL

If I make an assessment that a business is fundamentally undervalued by a significant order of magnitude (I'm talking about 20c or 30c-in-the-dollar stuff), then provided I can establish to my own satisfaction that the downside risk is negligible (and if you recall from some of my earlier posts, I am not talking about mere temporary capital loss, but permanent loss), then I will buy the stock.

And not in small doses.
With conviction.
I am happy to allocate 10% or 15% of my net worth to buying such a stock.

Of course, my experience is that often (mostly, in fact) in the process of my getting to the point of absolute certainty that the scope for permanent capital loss is as close to zero as I can possibly conceive it to be, it happens that the share price starts moving up.

And dramatically, on occasion.
Like 40% or 50% or 60%. Or even doubling.

But my philosophy is that I am happy to forgo the first 40% or 50% or even 100% of the upside to intrinsic value in exchange for the knowledge that my capital is protected.

I could illustrate this is by way of a few real-life examples, but that might be tedious for many already bored stiff by my sanctimonious sermonising, so I will just relate the way I go about investing directly to MSB.

And I’ll start with the most self-evident part (and this is the part where all the focus and attention of most investors is and, I daresay, provides the incentive for them to buy the stock):

If – and the significant element is “if” – MSB can crack the code and turn its scientific objectives to financial account – then I am sure the company will generate many multi-billions of dollars in Revenues and Profits for a long time.

A simple financial model (and I have constructed one to satisfy myself of this) will prove the financial potential of the company. In spades.

But there is nothing novel or unique about this assessment.
Everyone knows this.

So that’s PART 1 of my investment process done: Identifying the Upside Potential


STEP 2: DOWNSIDE POTENTIAL

This is where I suspect I have a starkly differing view that most others on this forum:

WHAT IS THE POTENTIAL DOWNSIDE TO THE STOCK PRICE FROM HERE?

Well, I have identified some issues that I consider – should they arise – would impair my investment capital. I will list a few:

• One of them is that the company needs to raise additional capital via another equity issue, which is sure to be dilutive to some extent.

• Another is that Teva walks away completely and offloads its stake in MSB.

• Yet another is that various Phase 3 trials are unsuccessful.

In some of those scenarios, the downside could be dramatic, to say the least.

Now, let me immediately pre-empt the inevitable barrage of:

“Oh, you are so negative! Those things will never happen. Teva is committed. MSB will definitely find a partner to fund Phase 3 of its disc trial. The science is proven. There’s no way they need to raise fresh equity”,

by saying that I happen to have the view that there is a greater than zero probability that one – or all of those potential adverse outcomes – will come to pass.

[Note: Not that I think they definitely will happen, or even that I think they are likely to happen. Just that there is a “greater than zero probability that they will happen.”]

Some might not agree with that view, and may believe that there is no more downside from here. If they want to believe that, then that’s a matter for them alone. It’s their money.

But I happen think that things might very well not go to “plan”, and if they don’t, that there might be further falls in the value of the company.

Mine is one of many opinions, I’m sure, and I don’t expect people to agree with me.

Now, back to your question about my strategy about making money out of MSB.

Well, let’s assume that the company somehow manages to avoid the dilutive equity raising that I believe looms sometime over the next 12 months.

And let’s assume they do so by partnering with someone and that the said partnering deal is a sensational one.

I will then evaluate the merits of such a deal in terms of its robustness, its transparency (noting that, to date, such arrangements have been very opaque), and its ability to provide MSB with capital adequacy to the point of commerciality.

As I have articulated before, my assessment (like it or not, it doesn’t matter to me) is that MSB is underfunded to the point of being commercially independent of all external funding sources.

Now, while this aspect appears - somewhat astonishingly, I think - unimportant to some people, it is critically important to me.


And then there’s the matter of Teva and its intentions going forward, pending the outcome of the interim analysis of the CHF trials (or maybe irrespective of the outcome, who knows?)

But let’s assume the trial results are successful, and Teva comes out and articulates in no uncertain terms (as opposed to the current terms which I find to be disconcertingly vague and lacking in volition – again, this is MY opinion based on the research I have conducted and on my interpretation of Teva’s strategy as well as the transcripts of management commentary in various forums…and gain, no one need agree with me.)

So, let’s assume they execute the mother of all funding deals AND the trials are all unambiguously successful AND Teva declares unequivocally that it is a committed long-term partner for MSB.

What happens then?

Well, then I think that the downside is limited, and the Reward-Risk asymmetry is skewed heavily in the favour of the fresh investor.

Then the company’s intrinsic value – which is a multiple of the current share price - will become bankable and, according to my investment process, I will begin to buy the stock.

Of course, needless to say, the share price will go up straight away. I recognise that.

It might go up 20%, or 30%, 50% or even 100% before I get chance to buy a single share.

But in this situation I will still be happy to buy because, while the upside might only be 300% and not 400% (given I missed the first 100%).

Recall that I am happy to forgo the first 30% or 40% or even 50% of the upside to intrinsic value in exchange for the knowledge that my capital is protected.

I think of this foregone upside as an insurance premium.
Insurance against capital loss.

And it is under that sort of set of circumstances that I believe I will make money out of investing in MSB.


In closing, I’d like to say that I find it completely bizarre that what I consider to be a most reasonable approach to investing, namely to consider deeply the things that could go wrong and potentially cause one to lose money, is met with such contempt and causes such egregious offence to the senses of some.

My approach is exactly why I have not bought MSB at $10.00, $9.00, $8.00, $7.00, $6.00, $5.00 and why I will not buy it yet: because my “downside” scenarios have not yet been eliminated.

For example, when I first started reading about MSB in November 2011, and at the time of I started doing work on the company, the conventional wisdom prevailing in the market at the time was that the Phase 3 heart trial was to commence recruiting patients in the March quarter of 2012.

As part of my habit of thinking about the potential downside, I remember quite clearly asking myself: but what if it doesn’t?

People who knew more than me about this kind of thing were expressing the view that it’s a complex trial, with a significant number of somewhat unique patients required.

My thinking, therefore, was about what would happen if the patient recruitment proved challenging or slow or if trial design documentation got bogged down in FDA bureaucracy or if Teva proved to be less willing a participant than Cephalon clearly was?

(As it happened, all of the above happened, to varying degrees, and to varying degrees these considerations remain unanswered in my mind today.)

If people choose to not account for the downside and are happy to have their capital at-risk, then that’s a matter for them.

I am of an acutely firm belief in the Ten Steps to Making Money on the Stock Market being:

STEP 1: DON’T LOSE MONEY
STEPS 2 to 10: REFER TO STEP 1

Now obviously no investment approach is 100% failsafe and sometimes adverse outcomes that I have failed to consider comes to pass. Mistakes are certainly made by me.

But most times it is possible to identify most potential negative outcomes, and to roughly quantify the impact they might have on the share price.

I have long given up trying to understand how people can look just at the prize, but not the potential pitfalls.

Everyone just looks at the positives, the “Science”, the Greatness of the Professor, the “Deal of the Year”, the Lonza manufacturing agreement and, until recently, the now-flawed view that MSB is fully funded to commercialisation.

But when you ask, “Um, what about the steps to get us to the stage where we get to profit from the science?” or “On the off chance that Teva – which, remember, has undergone significant strategic flux and management change and board upheaval since it acquired Cephalon four years ago – withdraws from supporting MSB, what happens then?”, or “What happens if Japanese registration fails to occur for some hitherto unconsidered reason?”, then you get shot down in flames as some sort of “disingenuous” heretic or “downramper” or insider trader or you have some sort of insidious agenda like trying to scare mum ‘n dad investors so that you can steal their shares.

To put it yet another way:

A number of things have to happen first before I will buy MSB shares, and they are by no means guaranteed to do so, but I am at liberty to keep abreast of developments which I will continue to do (despite the vitriol along the lines of “Negative!”, “Down-ramper!”, Disingenuous!” and the implications that I have no right to participate in making posts about MSB on HotCopper because I might be unduly influencing innocent and naive “mum ‘n dad” investors, like some predatory financial market charlatan, to divest their shares).

And when and if those things that need to happen first, do happen, then I can identify the scenario whereby I will make money out of investing in MSB.

What I almost certainly won’t do is LOSE money by investing in MSB too early.
Because I won’t commit my capital before that near-perfect scenario that I envisage unfolds.

In very shortness: I think I will make money out of MSB, but I certainly won’t lost money.

That about sums up the way I invest.

In case I haven’t laboured the point: downside protection is very important to me.

Why it isn’t to everybody, I will probably never be able to fathom.

That may, or may not answer your question, Antibody.

I hope it does so that I may continue monitoring MSB’s progress (and potential problems and downside) on the road to making an investment one day when I deem the circumstances to be right. Right for me and my investment style.

To pre-empt the inevitable, “Aw, Madam, you are so pessimistic; you think you can find the perfect investment situation? Well, they don’t exist. The very nature of the stock market should tell you that” my response is:

Yes, those sorts of situations do exist.
But admittedly not very often. They are quite rare.
But exist they do.

Identifying them requires patience and a rigorous and unrelenting pre-occupation not just with what can go right, but with what can go wrong.

I have followed companies for 3, 4 and even 5 years sometimes waiting for the optimal conditions to invest. And obviously, sometimes they never do.

But I sleep easy at night believing that my capital is secure.

It is my way of being PRUDENT.

If people choose to interpret that approach as anything other than that, then I am powerless to stop them.