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Why Lang & Pattisson are shorting Glaxo, SABMiller and Drax
by James Phillipps on Jan 14, 2014 at 12:41
The Jeremy Lang and Bill Pattisson-managed Ardevora UK Equity fund has a number of contrarian positions and they explain the rationale behind three of their top shorts.
Ardevora UK Equity has got off to a strong start
Jeremy Lang and Bill Pattisson founded Ardevora in 2010 after leaving Liontrust. The pair's UK Equity fund reaches its three year anniversary in the middle of February and has delivered almost double the sector average over one year, up 41.5% versus the peer group's 23.3%. Ben Fitchew and Gianluca Monaco, managers of the fund’s short book, highlight three of their key short positions for 2014
‘Glaxo is a classic example of an ex-growth company we look to short. These are businesses which enjoyed relatively easy growth in the past, but that now find life more difficult and need to stretch to find growth,’ Monaco says.
‘The stretch can be seen through the lens of capital allocation – which tends to be sizable and risky for this type of company, through either massive capital expenditure or outright acquisitions. Usually this is tied with management trying to focus investor attention on the new potential growth opportunities for the business, while glossing over a weaker core business.
‘Glaxo, which has just acquired Human Genome Sciences in the US, is a darling of income investors – who prefer to focus on its exposure to emerging markets, vaccines and consumer health. However, the reality is big pharma has been very profitable in the past, but there are clear signs these types of businesses are coming under pressure.
‘In a global context, we see this in the rise of profitability of biotech. In response, the pharma giants are trying to buy biotech intellectual property by acquiring biotech companies, usually at a hefty premium. It shows how desperate for growth these companies are.’
‘These are the types of businesses investors have loved buying through the wobblier periods over the past five years, namely safe-feeling global brands with exposure to emerging markets growth,’ Fitchew says.
‘This theme is interesting, as there is evidence of a clash between investor perceptions of risk, and the risk company managements are taking. On the one hand investors have become increasingly comfortable with the whole story of emerging markets growth propelling the big global franchises. On the other hand, more objective measures of risk show managements are stretching to find growth externally, as organic growth wanes.
‘SAB is a case in point. Its organic growth is slowing, with growth not as easy to achieve as it was in the past. Its past is the natural hook for investors. However, a classic sign of management stretching for growth was its heavily debt-funded acquisition of Fosters, where there are no obvious synergies. This is clear evidence management is becoming more aggressive in capital allocation and a sign the company is taking too much risk.’
‘We see a big increase in risk taking by management, as it is putting in a lot of capex to switch from coal to biomass,’ Fitchew says.
‘This type of shift in business model has a lot of forecast risk attached to it. It is a huge capital allocation project and a large risky bet. Many investors are focussed on the opportunity rather than the execution risk. We switched it into the short book in April.’