A few years back I bought a company in the communications services sector. That was a mistake. I stumbled in evaluating either the fidelity or the ability of incumbent managers and, I was wrong in my evaluation of the competitive position of the company. Last year, I lost confidence in the initial investment thesis and decided to sell all my shares at a loss. Perhaps, by reflecting on what went wrong, I am hoping to avoid similar mistakes in the future.
At the time of purchase, I paid a lower valuation than competitors despite having a better balance sheet and a reasonable value proposition. The management had just completed a successful deal that allowed them to pay off most of their debt, so the low valuation seemed puzzling, especially given favorable business conditions and a booming market. Confident, I made it a decently sized position.
During the past year or so, the company ran into several challenges. It saw the rise of competition, customers started leaving, rising interest rates squeezed cash flow due to high expenses on floating-rate debt, and litigation surfaced. Compounding these issues, management's questionable capital allocation decisions and unresponsive behavior weakened my conviction level in the investment, prompting me to exit the position entirely. As Mr. Warren Buffett wisely put it:
“In the world of business, bad news often surfaces serially: you see a cockroach in your kitchen; as the days go by, you meet his relatives,”
source: Berkshire Hathaway 2014 letter
Photo by Kyle Glenn on Unsplash
The company primarily served price-sensitive customers, while its competitors targeted the lower end of the market. It turned out that the company's customer base was more vulnerable to competition than I had initially realized. Management maintained that their customers were different, but they were losing them quarter after quarter—something I failed to fully appreciate early on.
Another red flag was a key executive selling a substantial portion of their personal shares. While insider sales aren't always a clear indicator (versus insider buys), the magnitude of these sales should have been a warning sign for me.
Lastly, during the pending litigation, the company continued buying back shares and investing heavily in growth, all while increasing its floating-rate debt—decisions that seemed reckless given the trial’s uncertainty. My attempts to engage with management went unanswered, which was the final straw. While the leadership seemed willing to weaken the balance sheet for growth, I wasn’t comfortable taking that risk.
Fortunately, I didn't make the mistake of not selling out as soon as I realized my mistake (I should say mistakes). Luckily, I have been able to recover all the losses by investing in another stock. This points to another lesson -- there’s more than one way to recover from a setback.
Regardless, I totally misjudged the competitive position and management of the company when I purchased the stock. Hopefully, having learned the lesson the hard way will help me avoid similar errors in the future.
Abhay Srivastava is the Founder and Managing Member of AS Investment Partners LLC, a value investing firm (www.asinvpartners.com).
