Faith in Net-Nets
If the balance sheet is very liquid and insider ownership is very high – there’s a good chance something will happen. I have no idea what. And I have no idea when. But someday, something will happen to increase the return on those assets…Sometimes it’s as simple as returning the assets to shareholders, using net cash to make a management buyout super cheap, or using net cash to buy a totally different business…When you buy a net-net you are not buying future earnings. You are buying future assets. What I’m talking about here is asset conversion. At some point, you are expecting today’s assets will be converted into something you can profit from. Something a control investor will pay for. Or something the market will reward.
It’s very hard to imagine these events ahead of time. But you can still bet on them:
That’s the uncertainty in net-nets. Most of the best net-nets have this certain/uncertain duality. It is certain the stock is selling for less than it’s worth. It is uncertain how the stock will ever sell for what it’s worth.
Remember what Ben Graham told the U.S. Senate:
The Chairman: When you find a special situation and you decide, just for illustration, that you can buy for 10 and it is worth 30, and you take a position, and then you cannot realize it until a lot of other people decide it is worth 30, how is that process brought about – by advertising or what happens?
Mr. Graham: That is one of the mysteries of our business, and it is a mystery to me as well as to everybody else. We know from experience that eventually the market catches up with value. It realizes it one way or another.