We are not interested in 10% off or even 20% off, because in the aggregate that does not give us adequate upside for our efforts. Our valuations could be off by such figures, or an adverse event affecting the company could reduce its value by the same.
With that in mind, consider Insmed (INSM), a pharmaceutical company that recently sold a significant portion of its assets to Merck for $130 million. As a result, while the company trades for $106 million, it now sits on $122 million of cash and only $3.5 million of total liabilities. Unfortunately, however, there are no other significant assets: the company continues to operate at a loss with its remaining product.
The company did state that it may distribute the funds to shareholders, but it may also continue to try to develop its IPLEX product. This is from the quarterly report from two weeks ago:
"...[W]e expect to incur significant additional losses for at least the next several years until such time as sufficient commercial revenues are generated to offset expenses."
Simply put, this cash does not represent enough of a margin of safety, because of the uncertain future. It's this same line of thinking, "large upside only", that has value investors like Seth Klarman more interested in fallen angels than in junk bonds, even if they were to trade with the same yield and risk characteristics: much higher upside exists for the fallen angels due to their large discounts from par. In other words, the reward makes it worth the risk. To ensure superior returns, value investors must demand strong margins of safety that not only reduce downside risk but also increase upside potential.