Watson sees an Advantage in talking up Strathmore price

By Brian Gaynor

Investment


Entrepreneur Eric Watson is rapidly becoming the uncrowned master of publicity and hype. His performance at this week's Strathmore annual general meeting, which had a big impact on the company's share price, has embellished this image.

Mr Watson, who attended the meeting as a 10.6 per cent shareholder, asked chairman Phil Norman whether there was any similarity between CommSoft, which is 21.6 per cent owned by Strathmore, and the high-flying Australian company Telemedia.

Mr Watson had pointed out that Telemedia had a sharemarket value of $A200 million ($254.45 million).

Mr Norman answered, with a broad smile, that CommSoft was "at least equals" to the Australian company.

The loaded question and extremely positive reply created a buzz of excitement among shareholders and they were not disappointed.

Immediately following the meeting Strathmore's share price leaped from 37c to 51c and its total market value from $68 million to $93 million.

It is difficult to understand why Mr Watson would want to talk up the share price of a company that has risen substantially in the previous three months. It is particularly difficult to comprehend in Strathmore's situation because the company has no profitable activities.

Corporate history is littered with companies that have become market favourites before establishing profitable activities. The promoters of these companies usually have a low entry price and their optimistic comments encourage other investors to purchase shares at a much higher price.

When these companies fail to meet expectations the new shareholders are the biggest losers because they have a much higher entry cost.

Mr Watson has two big listed IT investments, Advantage Corporation and Strathmore. His entry costs are extremely low - the average cost of his Advantage and Strathmore holdings are 35c and 6.2c per share respectively.

The current market value of these two shareholdings is $34.7 million compared with Mr Watson's total purchase price of just $3.3 million. These calculations assume he took up his rights to Strathmore's cash issue at 5c per share.

Mr Watson first became involved in Advantage in October last year when he purchased 4.7 million shares for 28c each. A month later he increased his shareholding to 15.4 per cent when he bought another parcel at 60c per share.

Since then Advantage has taken off. It has made numerous acquisitions including Computer Enhancements, PEC Retail, Glazier Systems and WebMasters; hired several senior executives; and reported a net profit of $3.4 million, on revenue of $21.2 million, for the June 1999 year.

The company's annual general meeting, held on November 19, was wildly optimistic. The hyped meetings of Bruce Judge and Allan Hawkins during the 1980s were tame by comparison.

Chairman Evan Christian opened proceedings with the bold statement that "Advantage was the most exciting growth stock in New Zealand."

Chief executive Greg Cross bragged that the company "will deliver significant capital growth to shareholders."

The central theme was that e-commerce was a boom industry similar to the gold rushes of last century.

Mr Cross said: "Our approach is simple. Get big fast. In design, orientation and execution, Advantage is a growth company. In the internet environment that means operating at speed. We enter markets early, target well and create value."

In the four weeks since the annual meeting Advantage's share price has risen from $2.30 to $4.15.

Mr Watson's involvement with Strathmore goes back to June this year when the Thomson family announced it would sell its 70.5 per cent shareholding to John Sorenson.

Mr Sorenson had no firm strategy when he signed the purchase agreement but he knew that Mr Watson's involvement would have a positive impact on Strathmore's share price.

Mr Sorenson convinced Advantage to take a 20 per cent holding and Mr Watson 10.6 per cent. These shares were acquired for 18c each (6.2c per share after adjusting for the recent 10 for one cash issue).

The "Watson factor" came into play and Strathmore's share price and market value began their strong upward momentum.

At this week's meeting directors announced the acquisition of a 50 per cent shareholding in CreditNet International for $1.15 million and a new licensing agreement for CommSoft's internet PABX software system in Europe. Strathmore purchased a 21.6 per cent shareholding in CommSoft for $1.3 million a few months earlier.

One of the most disappointing aspects of the meeting was the lack of opposition to the proposed issue of 27.5 million options (representing 15 per cent of the company's capital) to directors and staff. The exercise price of these options is 80 per cent at 20c per share and 20 per cent at 40c per share.

It is amazing that after the massive fallout from the excesses of the 1980s not one shareholder challenged Strathmore's generous options issue.

Large and generous options issues are an unhealthy product of most bull markets. Directors can hype up their company's share price on vague and optimistic information in a buoyant environment. Outside shareholders, who purchase shares at inflated prices, carry most of the risk while the option holders have everything to gain but nothing to lose.

The big question now is how does one value Advantage and Strathmore and what is a realistic share price for both companies. This is a difficult question to answer because most of the traditional valuation models have been made redundant by the IT boom on New York's Nasdaq Stock Exchange.

US analysts have thrown out their price/earnings models for internet-related stocks and now rely on a sharemarket value to sales ratio. They take a company's sharemarket value and divide it by the latest quarterly sales figure (multiply by four). Even this has limited value because there are considerable variations in the ratio - Yahoo has a market value equal to 141 times annual sales, eBay 83 times and Amazon.com 23 times.

Strathmore's share price is the hardest to justify. At one stage this week its market value exceeded $117 million and, at yesterday's closing price of 50c per share it had a market capitalisation of $91.6 million. This compares with assets of just $10.9 million; $8.5 million in cash and $2.4 million recently invested in CommSoft and CreditNet.

Although Strathmore's share price may continue to ride the internet boom, shareholders should remember that Direct Capital, which was a similar type company, traded at a large discount to asset backing. Strathmore's market value is more than eight times its asset values.

At yesterday's closing price of $4.15 Advantage has a market capitalisation of $207.4 million, an historic price/earnings ratio of 61 and a value to sales ratio of 3.3. On a traditional valuation basis the stock is overpriced but compared with overseas IT companies it is not expensive.

Advantage's share price could go higher but the smart investors, including Mr Watson, Mr Christian and the other main shareholders are unlikely to be purchasing shares at current levels. Some may even be sellers as Royal & SunAlliance announced during the week that it had reduced its shareholding from 9.2 to 4.4 per cent. It has since sold the remainder to an offshore fund manager.

* Disclosure of interests: Brian Gaynor is an Advantage and Strathmore shareholder.