17
Apr
2017

Same balancesheet, different stories

The key to all story telling is to give your audience what they want, but not the way they expect…Robert McKee

I like stories. They are the way we interpret contradictory information and understand different perspectives. If you want to change someone’s mind, psychology research suggests that appeals to reasoned argument don’t work. Think of all those climate change debates, no one ever says “oh, you have made a convincing argument, and now I will change my mind”.

Telling a story works much better.*
A good plot points the reader in one direction, then as it looks predictable, the narrative is turned upside down and given a new perspective. Conan Doyle was a master of this, Sherlock Holmes is obsessed by some small detail that everyone else thinks is irrelevant…and that small detail (a missing dumbbell, a dog that doesn’t bark, a stray foot print) turns out to be hugely significant.

Story: a term of abuse

Companies tell stories. “Story stocks” is a term of abuse among value investors. It means a company that is a long way from making a profit, or overvalued on traditional financial ratios but can justify this with a great story about future prospects. An example might be Intelligent Energy (hydrogen fuel cells) or United Cacao (cacao plantation in Peru). Often these stories are convincing, but small details overlooked mean that they turn out to be duff investments.
But some story stocks can be fantastic (Fever Tree). So I like to spend time thinking about the stories. A computer can manipulate numbers, it can easily calculate a price/earnings ratio or a dividend yield…but none of my programming friends are interested in analysing words and stories.
As an example, I own a couple of baggers (both have doubled) and although the companies do similar things, and have similar balance sheets (both in terms of composition and size)… they have very different stories. One of the companies is 13x more valuable than the other.

13x more valuable

It’s tempting to say that there is a mispricing of fundamental value, sell the expensive one and buy more of the cheaper one. That is what a value investor would do. I’m not convinced, I think something else is going on – and it is to do with intangible assets. It’s the difference between a Ferrari and Fiat…which are actually the same company but different brands, different stories.

The art of steering heads inside

The first company is a Public Relations and marketing firm. The Mission Marketing Group, which I bought a few years ago because it was obviously cheap. And it’s doubled since I bought it in 2011. Which is OK, but not brilliant – I’m looking for companies that can increase in value 5 or even 10x. It trades on 7x historic earnings (ie bargain basement). Branding, Advertising, Media, Events and Public Relations, that sort of thing. The Mission customers are Barclaycard, WKD, Highland Spring water. Very intangible, but if you can manipulate what the public think, that’s very valuable. The art of steering heads inside. If you can persuade someone to buy one specific brand of brown sugary drink that really helps profit, at least to the brown sugary drink company, if not to the consumer.
Around 2/3 of The Mission’s balance sheet is intangible assets. By contrast, tangible stuff like “Property, Plant and Equipment” is less than 3%. The tangible book value of the company is actually negative. That is, if you deduct intangible assets from book value, you get a negative number.

Using brands to increase sales

By contrast Keyword Studios trades on 70x historic earnings. That’s wildly more expensive, especially for reasonably similar companies.  Valuation table courtesy of stockopedia

Keyword also helps its customers develop their brands and increase sales while reducing globalization costs. The difference being that the Keywords customers do not make fizzy drinks, they are computer games publishers. Companies like Microsoft, Sony, Konami, Electronic Arts and Nintendo. Computer games are global, but they need to be tailored to specific local markets, not only linguistically correct but culturally adapted too.  They also create the artwork and the marketing.
I don’t think localisation and translation services or art work will ever be replaced by a computer. It’s something that is easy for a person to do, but hard for a computer. And the stakes are high, it is so embarrassing when you get things wrong. Originally the Rolls Royce “Silver Shadow” was going to be called the “Silver Mist” until someone pointed out that “mist” was “manure” in the German language. Or when Phil Knight, the founder of Nike shoes first visited Japan he found a shoe company that was making 3 types of sports shoes. The first, a training shoe was called “Limber Up”, the second a high jump shoe was called “Spring Up”. The third in the range was a discus and javelin shoe, which they had named “Throw Up”.

So what Keywords does is not particularly clever, but it is very specialised. They get native language testers play, test and report bugs in the localised versions of the computer games. It has a strong market position, 21 of the top 25 games companies by revenue and 7 of the top 10 mobile game companies by revenue. Games are like movies and start ups – there is a lot of kurtosis. A few huge smash hits like “Angry Birds” or “Minecraft” but it is hard to find a winning formula and repeat success. So, in that sort of high kurtosis industry, rather than heading down the goldmine in search of nuggets (low probability, large upside), it is normally a good idea to be the company selling shovels and blue jeans outside the goldmine (high probability, less upside).


Just over half of Keywords assets are intangible, and this is increasing as they have bought more companies. But the investors are prepared to give management the benefit of the doubt, that unlike The Mission, what they are buying is valuable. The company is trading on 45x tangible book value. I think that can probably be justified, because the industry is consolidating, and companies that focuses successfully on a niche have a genuine competitive advantage.
In contrast – PR and advertising is very fragmented. There are some global companies like WPP. But there are a lot of smaller ones. Ironically it is not clear how these companies compete. They spend all their time persuading customers not to buy on price, but on intangible “perceived value” – yet in my experience the PR industry is rather cut throat and competitive. Ironically, companies that spend all their time doing creative things to create “brands”, struggle to create their own competitive advantage.

Public Relations v Authenticity

I have some other vague concerns about PR as an industry. Perhaps the election of Donald Trump signals “peak PR”? Trump did everything wrong according to traditional PR, but now is seen as some sort of communications genius.  Or the popularity of craft beer.  This is also a story about people losing faith in the marketing of beer brands all owned by the same global company.

This says to me that traditional PR and marketing may need to learn new tricks.

I think customers and voters know they are being manipulated and can see through it. They value authenticity. Trump may be narcissistic, but he is also authentic.  Craft beer is about authenticity. Really good companies (Nike, Fever Tree, even Keyword Studios) can tell their own story. Why do they need to pay other people to manipulate their image? It should be core to what the company does.

Finally, I’ve noticed retailers talking about “investing in price cuts”. What they really mean is rather than spending money on brand awareness or marketing, retailers cut prices to buy market share. That suggests that some companies are losing faith in the power of PR and marketing.

chart source Stockopedia

You might expect PR companies to be good communicators themselves, they spend so much time manipulating stories, they should be experts. Actually the reverse is true, sometimes they fall for their own delusions. The Mission Marketing Group is laughably bad at communicating its investment case, in my view. Plus The Mission management come across poorly (to me at least). The shares are trading on desultory 5.5x forecast earnings (WPP by contrast is trading on 14x earnings). So TMMG share price is signalling that there is a problem with the company. But to me the company looks fine…Instead, it is the management who are the problem. They are being awarded with a “growth shares scheme” . Under this Scheme they subscribe for shares in their company at a nominal value of 0.01p. Then if the Company’s share price goes to 75p for three weeks, the shares convert to ordinary shares. If management just did their jobs properly, without a fancy incentive scheme they would actually achieve a higher share price, I think.
For now I own both. I really can’t bring myself to sell an undervalued company like The Mission, even though I think the story is rubbish. I feel distinctly uncomfortable about the valuation of Keywords, for now though I will trust in the power of its story.

*Redirect: The Surprising New Science of Psychological Change – Timothy Wilson
The Persuaders: The hidden industry that wants to change your mind – James Garvey
Story – Robert McKee

 

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