In search of small-cap takeover plays in 2014

Investment strategies vary, of course, but a tactic that all good investors utilize is a process to constantly revisit the thesis underlying each investment position. At Twinleaf Management, we frequently ask ourselves these questions:

Why do we continue to like the stock of a portfolio company at the current valuation? Has anything recently occurred that may have shifted our view of the company or industry? Is management executing as we anticipated when we originally made the investment? Is the risk-reward outcome still skewed decidedly in our favor?

We also try to look ahead 12 to 18 months and take a future snapshot of the company with as much clarity as possible. Anticipation is very important; investing in front of a catalyst is the key to investment outperformance.

This is obviously no simple task, given the thousands of market participants and inherent uncertainties. After all, no one’s crystal ball is clear all the time and anticipating correctly is especially difficult given Twinleaf’s focus on small caps.

Small cap investing can be treacherous — a single customer defection, a missed product launch date or a management misstep can produce a downside move in a stock. But the opposite effect is also true: the upside for anticipating a catalyst in a misunderstood or out-of-favor name can be significant.

At Twinleaf, our exclusive focus is not only finding compelling investment opportunities but getting there before others do, which means identifying companies that are deeply undervalued with an emerging catalyst that should it play out as we anticipate, is likely to rapidly narrow or erase the discount to fair value.

Our preferred, but not exclusive, investment catalyst is the prospect of a company being purchased by another firm or a private equity firm.  With few exceptions, if a company is not at least a plausible takeover candidate within an 18-month horizon, we don’t invest. Our objective is for at least one portfolio company per year to be the target of an M&A takeover bid; in 2013, we had two and we are optimistic for 2014.

It doesn’t always go as planned and outperforming is not easy, but we believe that having a narrow investment focus, performing diligent research and constantly revisiting the investment thesis is the key to long-term success.

In our next blog post, we’ll discuss the level of conviction in an investment idea and sizing positions accordingly.  We enjoy hearing from investors, so please feel free to contact us if you would like more information.

DISCLAIMER: The reader should not assume that any investments identified were or will be profitable or that any investment recommendations or investment decisions we make in the future will be profitable. Investments in securities of small-cap and growth companies may be especially volatile. Past performance is no guarantee of future results.