Multi bagger stocks lesson

Multi bagger stocks lesson

1. HSN Online billing Aug 2006

Hansen Technologies Limited (ASX: HSN) provides customer care and billing software to telco, pay TV, utility and water companies. If you had bought $10,000 of shares in Hansen 10 years ago, they would be worth almost $260,000 today, plus you would have received $30,000 in dividends and capital returns over the period.

Back in August 2006, Hansen had a market capitalisation of just $23.9 million. The company provided billing software to the utilities and telecoms industries through its HUB product and also offered outsourcing IT services to the financial industry.

Hidden value

Hansen was yet to report its full year result for 2006, but the half year report was not pretty. Revenues were down 15% to $24.3 million and the $266,000 profit before tax (PBT) in the prior period had swung to a loss of $1.3 million. Similarly, operating cash flows were negative and the company had spent $2.1 million on software development which it had capitalised rather than expensed.

Perhaps the only positive in the result was the balance sheet which showed $2 million in cash after adjusting for debt thanks to a receipt of $6.4 million from a share issue during the period. It is safe to say that I would not have bought shares in Hansen back in August 2006 based on its most recent set of accounts.

However, there were signs that things were turning around for Hansen. The half year report was accompanied by a press release explaining that the company’s poor performance was due to upfront costs related to implementing its software for new key global clients. These clients would generate long-term recurring revenues for little cost once the implementations had been completed.

Catalyst

In 2006, countries in Europe and Asia were deregulating their utilities industries which opened up new markets for customer billing software. Australia had already undergone similar changes and so Hansen was in a strong position to take advantage of this one-off opportunity.

International competitors would have to build new software from scratch to address the needs of customers, whereas Hansen could quickly adapt its HUB software to suit these markets. Speed to market was a significant advantage because customers were likely to stick with software once it had been implemented due to high switching costs.

Trustworthy management

Andrew Hansen was the Managing Director of Hansen in August 2006 and he still leads the company today. Back then, he owned 7.6% of the business and had recently contributed $300,000 in a rights issue in September 2005.

At the time, management communicated well with shareholders. For example, they clearly articulated the reasons for the disappointing result in the first half of 2006 and laid out a clear path for the company’s future.

Sound business model

Billing software is deeply embedded in clients’ workflows and so customer churn is very low. This is particularly true of large bureaucratic utility companies that are resilient to change and are very unlikely to go out of business. Therefore, each implementation can deliver many years of revenues for very little ongoing cost.

Hansen was barely able to keep afloat back in 2006, but the strength of its business model was plain to see. Once the company achieved greater scale through geographical diversification, profit margins improved and its share price followed.

2. MNF VoIP Jan 2010

MNF Group Ltd (ASX: MNF) owns and operates Australia’s largest Voice over Internet Protocol (VoIP) network as well as a global network with Points of Presence (POPs) on four continents. It sells IP telephony services to consumers, businesses of all sizes, governments and resellers.

If you had bought $10,000 worth of MNF shares six years ago, they would be worth over $420,000 today plus you would have received more than $20,000 in dividends. Back then, the company was called My Net Fone and had no international operations but other key characteristics have remained unchanged.

Financials

In mid-2010, My Net Fone had recently announced strong half year results which included record profit of $333,460 and revenue growth of 26.8% over the prior period. At 31 December 2009, the company had $1.3 million in cash and no debt and had just completed seven consecutive quarters of positive operating cash flow.

These results built on My Net Fone’s strong performance in 2009 when it recorded a maiden profit, a watershed moment for the company. Despite a clean balance sheet and annualised profits of nearly $700,000, My Net Fone had a market capitalisation of just $5.3 million in August 2010 placing it on a price-to-earnings ratio (PER) of under 10.

Macroeconomics

2010 was early on in the global transition from fixed landlines to Voice over Internet Protocol which enables voice and video communication over the internet. VoIP is cheaper than traditional phone systems because it doesn’t require a dedicated line and there is minimal capital outlay. Also with VoIP, features such as messaging and call handling can be tailored to individual customer needs and it is possible to answer incoming calls from anywhere with an internet connection.

These benefits suggest that eventually people will use VoIP for almost all voice communication. I think that this was also obvious in 2010 given there were over 500 million registered Skype users at the time.

People

In 2010, My Net Fone had four directors and all of them had been board members since the company listed in 2006. Andy Fung was the managing director and Rene Sugo was the technical director and they owned 25.7% of the company each. Today, both still work for MNF Group with Andy Fung a non-executive director and Rene Sugo the CEO.

Non-executive director, Michael Boorne, purchased $140,000 of stock in the first six months of 2010 taking his shareholding to 8.0% of the company. Directors making regular large stock purchases is usually a good sign, especially when they have been involved with the business for a long time.

Microeconomics

My Net Fone was and still is a defensive and scalable business. Provision of communication is an essential service and so is not impacted by economic swings.  Customers pay ongoing monthly fees and have little incentive to switch suppliers. Furthermore, each incremental customer costs little to service and maintain.

In February 2010, My Net Fone had 80,000 customers in Australia, of which 57% were consumers and 43% were businesses. The impact of losing any individual customer is very low with such a diverse customer base.

In 2009, My Net Fone won a Sydney Business Award in the “Information and Communications Technology” category and finished in the top three for the “Business of the Year” award. Such public recognition is independent verification of the quality of the company’s service offering at the time.

3. MFG financie Mar 2009

Magellan Financial Group Ltd (ASX: MFG) is a fund manager specialising in international investments offered to both retail and institutional clients. If you had bought $10,000 of shares in the company at the beginning of March 2009, they would be worth more than $700,000 today plus you would have also received dividends totalling $70,000.

Admittedly, buying shares in a fund manager at the height of the GFC would not have been easy given market sentiment at the time. However, Magellan was trading at a 50% discount to net assets half of which were unencumbered cash and so there was little chance of losing money.

When Magellan was launched at the end of 2006, the company raised $100 million to ensure that there would be no financial pressure to chase short-term results. This is an example of the long-term approach of founders Hamish Douglass and Chris Mackay who are both still major shareholders in the company today.

Prior to Magellan, Hamish Douglass was co-head of Global Banking at Deutsche Bank in Australasia and Chris Mackay was CEO of UBS in Australia. Their backgrounds implied that they had both the contacts to market Magellan’s funds effectively and the skillset to wisely manage international investments.

Magellan was and is still different to most other Australian retail fund managers in that it only manages international funds. In 2009 it may not have been possible to foresee the subsequent surge in popularity of overseas investing, but Magellan was clearly targeting a gap in the market at that time.

It was also clear that management and shareholder interests were well aligned as Hamish Douglass and Chris Mackay gave up considerable compensation in 2008 in return for equity in Magellan. They had previously been entitled to large management and performance fees but from March 2008 were paid a flat $250,000 per year.

Along with non-executive director Paul Lewis, the pair also bought a significant number of shares on market in October and November 2008. Paul Lewis bought 250,000 shares which are worth more than $6 million today whilst Hamish Douglass purchased 150,000 and Chris Mackay bought 80,000.

Not only were the interests of management and shareholder aligned, but Magellan also invested directly in its managed funds. This demonstrates that management were not chasing short-term performance fees at the expense of long-term returns.

Perhaps another sign of things to come was that the unlisted Magellan Global Fund delivered a return of 2% in the year to 30 September 2008, outperforming its benchmark by 20%. Although a year is generally too short a time period to judge investment ability, it is certainly more difficult to perform well when markets are in turmoil.

Fund management companies can make fantastic businesses because they have the potential to grow quickly using little capital. However, success depends on the ability of those in charge which is often hard to evaluate.

In 2009 the background, share purchases, investment approach and communication style of Magellan’s management team provided hints of the company’s rosy future. The fact that it was selling for less than half its asset backing made it an extremely low-risk investment proposition.

4. TPG telecom Mar 2009

TPG Telecom Ltd (ASX: TPM) is one of the largest telecoms providers in Australia today and services both the consumer and enterprise markets. If you had bought $10,000 of stock in TPG back in March 2009, it would be worth over $970,000 today plus you would have received almost $40,000 in dividends.

TPG was a private business until April 2008 when it merged with ASX-listed SP Telemedia Limited which was backed by Washington H. Soul Pattinson and Co. Ltd (ASX: SOL). Soul Patts is a highly regarded diversified investment company and has paid a dividend every year since it listed in 1903.

David Teoh founded TPG in 1984 and he was appointed CEO and chairman of the combined group following the merger. He still runs the company today and has been widely credited for its success.

Unsurprisingly given Soul Patts’ involvement, the acquisition of TPG in 2008 was a fantastic deal for SP Telemedia shareholders. SP Telemedia paid $150 million in cash and issued 270 million shares in return for a business generating $29 million of net profit after tax (NPAT). Based on SP Telemedia’s share price of 35 cents at the time, this represented a price-to-earnings ratio (PER) of 8.5.

However, TPG exceeded expectations delivering $38.3 million NPAT in 2008 and so effectively SP Telemedia paid an enterprise value-to-earnings ratio (EV/E) of just 6 for the business. Furthermore, TPG came with an extremely valuable broadband network which would improve profit margins of the combined entity and reduce its reliance on third party networks.

The cash component of the deal was financed with debt and it is impressive that a small company like SP Telemedia was able to get access to lending during the GFC. Use of debt was a sound move as it limited share dilution at a time when it was very expensive to issue equity.

Despite the transformational merger, shares in the group were trading at 13 cents by March 2009 implying an enterprise value of $234.7 million. In other words, you could buy both TPG and SP Telemedia for the same price that SP Telemedia had paid for TPG just under a year earlier.

This fact wasn’t lost on the chairman of Soul Patts, Robert Millner, who was a non-executive director of SP Telemedia at the time. He bought 600,000 shares in SP Telemedia that are worth over $7,500,000 today for less than $100,000 in December 2008.

SP Telemedia reported headline losses in 2008 and perhaps this was one of the reasons for the low share price at the time. However, excluding write-offs of bad debts and commissions related to discontinued operations, the group delivered earnings before interest, tax, depreciation and amortisation (EBITDA) of $46.6 million for the year.

This included only a couple of months’ contribution from TPG and so guided EBITDA for 2009 was much higher at $93 million. Forecast NPAT was just $16 million but included large non cash amortisation charges related to acquired customers hiding the true level of free cash generated of the business which was closer to $45 million.

In early 2009 it was possible to buy shares in TPG for an EV/E of about 5. This was extremely cheap for a company that owned valuable broadband infrastructure at a time when demand for bandwidth was growing rapidly year on year. Furthermore, it was and still is a highly scalable defensive business with sticky recurring revenues and an astute board of directors.

5. ALU software ciruit board Jul 2011

Altium Limited (ASX: ALU) develops and sells software used to design printed circuit boards (PCBs). If you had bought $10,000 of Altium stock five years ago, it would be worth over $610,000 today plus you would have received $45,000 in dividends.

Back in 2011, Altium had announced substantial losses in its recent financial reports but was generating positive cash flows. Despite expensing most of its R&D, the company had high amortisation charges relating to acquired intellectual property and capitalised R&D from years gone by. In effect it was double counting R&D spend which artificially supressed profits.

Further hidden value could be found in its growing deferred revenue liability. This liability represented annual subscription fees paid upfront by customers and so a growing balance implied higher levels of recurring revenue in future periods.

Indeed, in an announcement on 19 July 2011 Altium said that 40% of 2011 sales were from subscriptions, up from 27% a year earlier. Similarly, the number of active licenses had risen to 18,000 by 30 June 2011, up from 11,000 in the prior period. Growing subscriptions signalled Altium’s transition from a traditional software company to a cloud based SaaS provider which would unlock operating leverage and drive earnings growth in future years.

Another clue that a turnaround was taking place was the acquisition in November 2010 of Morfik, a cloud application development company. In return for Morfik, the vendors received 13.3 million shares in Altium worth $2.4 million at the time. Morfik’s CEO Aram Mirkazemi was appointed Altium’s chief of engineering and is now the company’s CEO.

Altium was generating between $1 million and $2 million in free cash flows per year back in 2011 and had $3.4 million in net cash at 31 December 2010. Despite this, it had a market capitalisation of just $12.3 million.

No wonder the directors were aggressively buying shares at the time. Non-executive director Sam Weiss acquired 700,000 shares between September 2010 and May 2011. Not content with the 6.7 million shares he received from the Morfik sale, Aram Mirkazemi bought another 2 million shares in Altium at 13 cents per share in December 2010.

Since the transition to a recurring revenue model in 2011, Altium has gone from strength to strength and today its prospects look brighter than ever. The company always had excellent technology capabilities, but it was only when these were coupled with an attractive business model that it was able to thrive.

6. REA Apr 2003

Online property classifieds business REA Group Limited (ASX: REA) has been one of the ASX’s top performers over recent times. The shares have been rising on a virtually uninterrupted trajectory for well over 10 years. If you had been farsighted enough to pick up $10,000 of shares back in April 2003, then you would be sitting on an asset worth $2.5 million today, plus you would have received $120,000 in dividends.

In April 2003 realestate.com.au, as REA Group was called back then, had recently announced its half year financials. Revenue grew 28.9% to $4 million for the half and although the company reported a loss, operating cash flows were positive. The divergence between cash flows and profits was caused by a depreciation charge relating to advertising services provided by News Limited in return for shares issued in 2001.

More importantly, realestate.com.au was the outright leader in the Australian online real estate market on numerous measures by the start of 2003. For example, in January 2003 it recorded 677,000 unique visitors to its site, more than its two nearest competitors combined.

The company had a market capitalisation of $22.2 million in early 2003 making it a true microcap, but it could be argued that the stock was expensive at this price given the business was barely profitable. However, several half years of consecutive growth up to the first half of 2003 in both sales and earnings before interest, tax, depreciation and amortisation (EBITDA) suggested a bright future for the company.

John Niland was the chairman of realestate.com.au in 2003 and acquired almost 100,000 shares on market at the end of 2002 in a show of confidence in the company’s future. The fact that Ray White Real Estate, NineMSN and News Limited all had significant ownership interests at the time further hinted at the potential of the company.

Undoubtedly one of the best quality businesses on the ASX today, REA Group was an unprofitable microcap in 2003 that most people would have considered too speculative to invest in. Of course, most of the time it is the correct decision not to invest in these types of businesses because they end up destroying shareholder value. However, realestate.com.au stood out from the crowd because of the quality of its shareholder base and the fact that it was the market leader in a high growth segment.

Emerging trends

Having looked at six 10 baggers so far, some trends are emerging.

  1. All six had market capitalisations of less than $100 million
  2. In five out of six cases, board members were buying shares on market
  3. All six companies were and still are scalable businesses with competitive advantages operating in growing markets
  4. In five out of six cases, headline profit figures from recent reports understated the company’s true ability to generate free cash

7. RHC health care Apr 2000

Private hospital operator Ramsay Health Care Limited (ASX: RHC) has transformed itself from an $87 million microcap in April 2000 to a $15.5 billion juggernaut today. In the process its share price has risen a staggering 9,400% and so a $10,000 investment back then would now be worth $950,000. The icing on the cake would have been the ever increasing stream of dividends contributing a further $80,000 while you waited.

Back in April 2000, Ramsey had just released its half yearly report. The company was negotiating a tricky period during which it chose to discontinue two developments, the Princess Alexandra Hospital and Berwick Community Hospital. These decisions had an adverse impact on profitability and although revenue rose 35.2% to $162 million in the first half of 2000, net profit after tax (NPAT) was down 33.1% to $2.7 million. The balance sheet also looked stretched relative to earnings as the company had $229.6 million in net debt.

However, the company’s established hospitals were performing well with revenue up 12.3% and earnings before interest and tax (EBIT) up 18.7% for the half. At the time the market seems to have ignored this given the company’s 30% share price fall from 14 January 2000 to 14 April 2000.

Pulse Health Limited (ASX: PHG) is experiencing a similar situation today with expenses related to recent acquisitions and newly opened hospitals masking the performance of its established operations. Pulse delivered revenue of $34.9 million, up 28.9% on last year for the first half of 2016 but lost money at the NPAT level thanks partly to the ramp-up of its recently opened Gold Coast Surgical Hospital. On an underlying basis, NPAT actually rose 57.5% to $2.9 million.

Like Ramsey’s before it, Pulse Health’s share price has struggled in recent months. The stock is down 46% in the last year thanks to a combination of tough market conditions, delays to the Gold Coast Hospital reaching profitability and aborted acquisitions.

For both Ramsey in 2000 and Pulse today, reported profits belie the true value of the assets in their respective portfolios and this seems to have escaped the market on both occasions. It is no wonder that Pulse has been the subject of a takeover proposal recently.

Parallels also exist in terms of industry conditions in each case, perhaps also affecting market sentiment then and now. Back in 2000 Ramsey’s new hospitals were struggling to reach profitability due to a pricing squeeze by health funds and a similar situation exists today. Shares in medical device distributor Lifehealthcare Group Ltd (ASX: LHC) were sold off earlier this year on fears that the recent Private Health Insurance (PHI) review would lead to lower prices for the company’s products.

It is important to point out that that Pulse is unlikely to go on to be as successful as Ramsey for a myriad of possible reasons, many of which are unknowable. In terms of the former, firstly, Pulse today is much smaller than Ramsey was in 2000 as demonstrated by its lower revenue and fixed asset base. Ramsey had $436.5 million in fixed assets at the end of 1999 compared to just $19.2 million for Pulse reflecting the fact that unlike Ramsey, Pulse does not own any of the hospitals under its management.

Another significant difference between Ramsay then and Pulse now is the ownership interests of their boards. In 2000 then chairman Paul Ramsey, who has now sadly passed away, owned 40.2% of Ramsay whereas the combined shareholding of Pulse’s directors today is less than 3%.

In truth, there is little chance that Pulse will reach the heights of Ramsey but that doesn’t make it a bad investment. Even a fraction of Ramsay performance will reward shareholders handsomely and given recent corporate activity it seems that I am not the only one who sees value in Pulse at current prices.

8. VTG telco Jul 2011

Telco retailer Vita Group Limited (ASX: VTG) had a market capitalisation of $31.3 million five years ago compared to $733.9 million today. Its share price has risen more than 20 fold over this time and the company has generated a further 150% of shareholder returns in the form of dividends.

In the light of Vita’s excellent 2016 results released yesterday, we can examine how much of this outperformance is due to business performance compared to market repricing.

Back in 2011, Vita delivered earnings before interest, tax, depreciation and amortisation (EBITDA) of $18.5 million for the year. However, the result included $9.6 million of trailing commissions relating to an old agreement with Telstra and so these ought to be excluded to understand underlying profitability at the time.

Based on underlying EBITDA Vita was trading on an enterprise value-to-EBITDA multiple of 4.3 in August 2011 compared to 11.7 today. Roughly speaking, the stock’s 20-fold price rise can be attributed to it becoming three times more expensive combined with a seven times growth in profit per share. This illustrates the power of combining a cheap price with a quality business, although the low purchase price was less significant than the company’s subsequent performance.

Still, multiple expansion is responsible for a large chunk of shareholder returns in the case of Vita and other examples in this series. I generally take a multi-year low as my hypothetical buy price which typically coincides with poor market, industry or company specific sentiment and hence represents a low earnings multiple. In contrast, today most of these stocks are trading at demanding prices thanks partly to the low interest rate environment, but also due to strong business performance.

It could be argued that the repricing of Vita stock over the last five years was due partly to a rising market affecting all stocks and that today prices look expensive across the board. If so, perhaps Vita’s current share price actually overstates the true value of the company. Therefore, the true value of buying Vita cheaply in 2011 is less than implied by the subsequent multiple expansion increasing the relative importance of quality over price in this case.

So if quality is the key factor then how did Vita manage to increase underlying EBITDA seven times in five years with little recourse to additional capital? Much has been made of the company’s customer focused culture which is a great source of pride for CEO, founder and largest shareholder Maxine Horne.

However, the deal with Telstra struck back in 2009 also seems significant as it led to Vita replacing its Fone Zone stores with the far more profitable Telstra branded outlets over the following years. In my view, Vita’s use of the powerful Telstra brand has been a huge benefit to the company and is a major driver behind its recent success. Given Maxine Horne founded the company, it seems likely that Vita’s celebrated culture was in place long before this deal was struck and yet for many years the company struggled.

Of course there are likely to be many other potential factors for Vita’s extraordinary performance. These include the general growth in the mobile phone market over recent years and other aspects of the 2009 Telstra deal, such as the shift from a trailing commission structure to higher upfront payments.

Whilst Vita’s culture is undoubtedly a key component of the company’s impressive recent history, it was only when it was combined with Telstra’s powerful brand that it began to yield results. Regardless, it is hard to imagine Vita thriving without the dedication of founder Maxine Horne and her passion for exceptional customer service.

9. Lithium

Core Lithium Ltd (ASX: CXO).

The Core Lithium share price has gone from 8 cents on 4 December 2020 to 87 cents today.

So, the lithium stock is now worth more than 10 times its value just over two years ago.

It’s a 990% gain if you prefer percentage terms.

Let’s compare this performance with other ASX 200 lithium shares over the same time frame.

  • Pilbara Minerals Ltd (ASX: PLS) share price up 462% from 71 cents then to $3.99 now
  • Allkem Ltd (ASX: AKE) share price up 204% from $3.97 then to $12.08 now
  • IGO Ltd (ASX: IGO) share price up 153% from $5.04 then to $12.79 now
  • Mineral Resources Ltd (ASX: MIN) share price up 133% from $34.56 then to $80.79 now.

Core Lithium has actually traded at a much higher price than where it is today.

The Core Lithium share price hit a peak of $1.88 in November 2022.

So, at that point Core Lithium had achieved a 2,250% gain in less than two years. And it still hadn’t made a cent from lithium sales yet!

10. Other notes

This decade’s 10-bagger shares are likely to have many characteristics of these companies. They will likely be technology focused or technology adaptors and productive users of capital, consistently improving revenue and profits. I do not think that many of these companies have finished their growth stages yet.

For example, Northern Star clearly has global domination in its sights. Altium has a 10-year track record of excellent growth with no signs of stopping. And Magellan is run by one of the most respected investors the nation has ever produced. 

Appen Ltd (ASX: APX) provides or improves data used for the development of machine learning and artificial intelligence products. It works with some of the world’s leading technology companies. This has included working with Apple Inc. on its voice assistant “Siri”. Since listing in 2015, this company has grown over 54 times. 

Magellan Financial Group Ltd (ASX: MFG) is the definition of compound growth. Smart investing in US growth shares has given this company a massive CAGR of 52.4% over the past 10 years. Its share price today is 66.6 times larger than on 1 January 2010. An investment of $10,000 at that time would now be worth ~$656,000. It holds significant stakes in some of the worlds largest companies and has done so since very early in their growth. These have included Apple, Facebook, Alphabet (Google) and business software giant SAP. 

Altium Limited (ASX: ALU) is, I think, one of the truly spectacular performers on the ASX across many areas. This company is not a 10-bagger share, it is a 100-bagger. It sells PC-based electronics design software for engineers who design printed circuit boards. Over the 10 years in question, it has achieved compound annual growth rates (CAGR) across sales, earnings per share, and equity growth well in excess of 10%. With a share price CAGR of 65%, Altium would have grown a 2010 investment just over 146 times.

Northern Star Resources Ltd (ASX: NST)

The dominant share across the past decade has of course been gold miner Northern Star Resources Ltd (ASX: NST). If you had invested $10,000 with Northern Star on 1 January 2010 it would be worth over $4,700,000 today (at the time of writing). A growth rate of 479 times is the stuff that dreams are made of. The current high gold price has helped in during 2020. Still, most of its share price growth happened between 2014 and February, 2020 – a period entirely pre-pandemic. 

The company’s secret formula has been to buy well, increase the gold reserves, increase the production and profitability, and divest itself of poorly performing assets quickly. 

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