has limited cash resources, which raise substantial
doubt about its ability to continue as a going concern”.
The company kept itself alive through a string of capital
raisings and by taking on debt. Tapping investors for
equity isn’t always bad but in Unilife’s case it resulted
in constant and excessive dilution. In the decade to
2014, the share count increased tenfold. Even for rapidly
growing companies, it would be hard for shareholders
to come out ahead after so much dilution.
Unilife’s balance sheet was also in a shambles – net
debt had grown from $US5m to $US54m in the three
years before our recommendation, and has grown to
$US117m since. The company had no tangible book
value in 2014, meaning a bankruptcy would leave the
stock next to worthless.
The most distasteful part, however, was that Unilife
had requested that it be allowed to omit certain lending
covenants from its public filings. This made it practically
impossible for investors to assess whether the company
was close to default. Maybe that was the point; who
knows? When a company starts playing smoke and
mirrors with its balance sheet, we suggest one action:
Don’t walk. Run.MARGIN OF SAFETY
Finally, there was the share price. With a 2014 market
cap that was 24 times revenue, Unilife was being priced
for significant growth despite its history of miserly
performance, such was the magnetism of its story.
If there’s one sin that will do you in as an investor,
it’s overpaying.
With all these reasons to dislike Unilife when we
first came to the stock in late 2014, you might think
our decision to avoid it must have been howlingly
obvious at the time. But it wasn’t. There were plenty
of counter-arguments and many smart investors saw
reason to invest.
Predicting failure is hard enough; predicting when
a company will fail is even harder. Indeed, Unilife’s
stock rose 60% in the month immediately after our
recommendation before things started to unravel. If
youwanttosleepwellatnight,bepreparedtolook
foolishduringtheday.
One last point is that taking a cautious approach to
stocks–demandingamarginofsafety,andsteering
clear of overpaid and underperforming managements
and dirty balance sheets – means you will have plenty
of missed opportunities. Ugly stocks can still be beaten
downtoofar,onlytohavetheirsharepricesrebound
spectacularly as things improve.
These missed opportunities are annoying but they
should be celebrated. They’re a reminder that you have
strict investment criteria – and, with that, you’re far more
likely to avoid the next disaster-in-waiting.Graham Witcomb is research director of Intelligent Investor.
To unlock Intelligent Investor stock research and buy
recommendations, take out a 15-day trial membership.clauses that mean management can keep issuing shares
at a low price, even if targets are missed. Without a
watermark clause, you lose one of the only incentives
an option-hungry management has to focus on growing
the company.
Nepotism is another problem. A chief executive may
slowly increase his or her grip on a business by hiring
friends and family to top positions. Checks and balances
on decision-making are gradually eroded and you can
end up with less experienced managers running the
show. Shortall’s brother was recruited as senior vice
president in 2009 despite almost no apparent industry
experience. How well would our Olympic swim team
do if the committee had to choose whole families rather
than individuals?
The bottom line is you can’t do a good deal unless
you have good people. However, the biggest corporate
blow-ups almost always have one other factor at play:
a dirty balance sheet.
A FOUR-LETTER WORD
Unilife hasn’t turned a profit in 15 years. In 2013, the
company’s auditor even went so far as to say Unilife
had “incurred recurring losses from operations and
“More red
flags were
flying over
the company
than at
a 1960s
communist
rally”