building a case for a conti play

Dear Aussie friends,
I am from the UK and I have been thinking for sometime about about a short/medium play on Conti and I think I have a reasonable case. I know most of you are very angry and disappointed with Conti management and I fully understand this. After reading this post, I hope some of you will be a little less angry and sad and will go onto read a few other posts of mine where I try to build up Conti play case logically. See if any of you agree. If some of you do get persuaded by my arguments, we may need to join hands for some shareholder activism at some stage. This post is somewhat philosophic. In my other posts, where my thoughts have been developed over the last few weeks, I sometimes refer to Conti as COOL.

This post is about the (a) importance of recognition of suitable entry points and exit points in investing in inherently risky small/medium caps, and the interactions with (b) the other important objective of the stockmarket's role as a source of funding for growing industries and long term economic efficiency and welfare aspects of this source.

Quite often a new technology (could be internet, mobile telephony, photo voltaic cells, electric bulbs or advent of steam engines) or a new need (could be commodities, medicine, or chemicals) sets off a investment cycle rush into small caps in this new sector. At the blue sky stage (usually before production), you can make a lot of money by even arbitrarily investing in this sector. Quite often, the challenge is to be feeling confident about the general story (and trend) rather than the qualities of the particular company. History is replete with such bursts of investment activity - from the great railway rush of the 1800s (After James Watt's work and George Stephenson's invention of the steam engine), to the telephony rush in the early 1900s (after Graham Bell's invention), to the chemicals/pharmaceutical rush in the 50s/60s, to the biotechs rush in the nineties, to the dotcom and mobile telephony rush in the nineties, or to the photovoltaic cell rush in more recent times.

At some stage, there is a market shakeout either brought on by difficulties to raise finance or more generally a realization that the pie is not big enough for so many small players. The successful ones which have survived the shakeout buy assets cheap from the detritus left from the unwanteds, and quite often become the established large caps who define the technical standards of the new industry.

It is obvious that entry/exit points with respect to the market shakeout time is critical for investment success in the above story. And great minds have made mistakes identifying the shakeout time. Isaac Newton did not see that he was holding onto a burst Ponzi Scheme when the South Sea Bubble burst. John Maynard Keynes lost a lot of money around the Great Depression from timing problems even though he had so much to say about the economic policies from the times (which we still use) . However Charles Darwin made huge money by timing the railways rush of the 1800s correctly - to the extent that more or less paid for his reasearch. He did not need to work in an university (his wife's family was rich though) while he was thinking about evolution/natural selection.

Beyond the market shakekout point, investments in small/medium cap in the relevant can only be taken on a very carefully thought out case by case basis. The general story of one tide lifting all boats is over.

In the commodities sector, for the small-cap miners, I believe that we are beyond the market shakeout point in this cycle (cost of capital effects on NPV calculations as I will argue in future posts). For most remaining small mining explorers/developers, the game should be an asset sale story (detritus of the unwanteds) if a bigger large cap miner wants their assets. I also believe that investment into Conti has an attractive entry point (this is the case-by-case basis of the previous para) now if they try to sell their attractive assets to bigger players. The only strategy which counts to me is how they arrange the bidding. I would not play Conti as a general commodity play on the other side of the market shakeout point even though they have good safety nets of 3 producing mines.

Now point (b) in my second paragraph. You and I may have lost money in mistiming the cycle, but more often than not, society benefits enormously from the particular investment rush. What remains from the detritus is valuable. Think of the extremely cheap access to high speed internet access or the high quality mobile telephony that we have today from the dotcom excesses; many of the fibre optic networks of the time had to be sold off cheaply in the crash now form the backbone of these networks. The railway rush of the 1800s have seen ninety five percent or more of the railway companies disappear but we are still using those networks after more than hundred years. If you think, you will probably find that there is an inherent conflict between (a) and (b) for the investors - most people will lose money by mistiming entry points in the great rushes, while society largely benefits at the end of it.

For Conti's case, early investors are very angry that they have lost so much money, that the management is bad, and while that maybe true, a lot of it is actually mistiming the cycle. At least society has benefited in some sense as resources of Mashala (who were too small) has been cleaned up and brought to focus; some new production (and additional jobs) have been generated. Society will benefit further if these resources move to bigger players now and brought to production quickly. That is the case specific entry point that I am playing.