Thursday, March 15, 2012

Lesson learnt from my mistake with Lakeland


Not buying LAKE was one of my biggest mistakes in 2011. This has led me to rethink how to judge risk/reward balance in net-net investments.

Lakeland (LAKE) is a protective clothing manufacturer. It's a microcap with a current market cap of  $54m. I looked at on and off for nine months with a passing interest. In November last year, it traded below $7.00, that was 20% below its net current asset value (NCAV) and 50% below its book value. That got me very interested and I took closer look. Whopper Investments has a nice writeup of the investment thesis on his blog. I'm not going to repeat the analysis here.

To cut the story short, I was troubled by their Brazil VAT liabilities. I couldn't reconcile the figures disclosed in the cashflow statements with the details else where in the 10-K. Together with a few circumstantial facts*, I started wondering if there was fraud at LAKE. After some email exchanges with Whopper and some more thoughts, I dismissed the fraud idea because there wasn't much incentive for the management to do so. But I did conclude their VAT mess (resulted from an acquisition) was a result of bad management. I concluded their incompetency would destroy value and their good ROE in past years was pure luck. Later in their fourth quarter result, they shuffled the India money losing operation into "discontined operation". That further enforced my thinking. With no catalyst in sight, I was worried that they would bleed money in foreseeable future.

Fast forward to today. LAKE is now trading at $10.50. That's 40% return in less than 3 months. What has happened? In December before Christmas, Ansell, an Australian protective clothing company, took a 9.7% stake in LAKE.

What's gone wrong in my reasoning?

I always wanted an exit strategy or catalyst in place but there wasn't one. I forgot a net-net is a net-net because it has a few warts and no obvious resolution in sight. Otherwise it won't be a net-net. Buying a net-net is basically a calculated bet on some "positive black-swan" event, if you wish, that some positive event you have no way to anticipate or foresee will happen. At the same time, the backing of the assets gives you the staying power and downside protection.

p.s. If you don't know what a black swan is in the context of investing, read Nassim Taleb's Black Swan or Fooled by Randomless.


*  Other circumstantial facts I found: (1) the proxy-advisory firm Institutional Shareholder Services (ISS) has advised sharesholders to vote against director John Kreft (sitting on the audit committee) and Lakeland's audit WAKM in its Jun 2011 AGM, objecting the high non-auditing fee paid to WAKM. Kreft nearly lost his seat.  (2) Lakeland only switched to WAKM it the last couple of years. Switching accounting firm always raises concern. (3) WAKM was being sued for negligence in auditing of a bankrupt furniture maker.

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