Friday, May 21, 2010


Two companies may have the exact same financial statements, and yet one may be a value investment while the other is not. This is because management's intentions play a big role in determining what kind of investor would find a stock attractive. (For example, consider two companies with large cash balances. If one intends to to use the cash to buy back shares while the other intends to invest the cash to find a new blockbuster drug, the investor profile of each company should look very different.)

As such, it is important that management communicate its intentions with shareholders. Recently, we saw an example of the kind of backlash that can happen when shareholders don't know what to expect. On the other hand, when shareholders do know what to expect, it can lead to a win-win for all.

Few companies are as good at communicating their intentions as Quest Capital (QCC). When the economy turned south, Quest made it very clear that it would stop its lending operations and instead focus on collections. This may have caused shareholders who are primarily interested in earnings to sell their shares, but it also piqued the interest of those looking to buy loan portfolios at a discount. In this way, Quest altered its shareholder profile to one that is in harmony with management's objectives.

When cash inflows far outpaced cash outflows (since the company was no longer lending), Quest made it clear that it would use proceeds to pay down debt and buy out preferred shareholders. This would turn off those looking for leveraged real-estate real-estate returns, but would result in shareholders of a more conservative, value orientation.

Now that debts and preferred shares have been paid down, the company recently announced that it would seek to close the gap between its share price and its book value. The company then went on to buy up almost 10% of its shares in the last five months, doing exactly what it said it would do.

So what's next? Quest's chairman issued the following statement two weeks ago:

"We expect further [loan] monetization to occur and while we have recommenced lending on a cautious basis, we do not anticipate utilizing all of our cash over the near term. In the interim, we continue to look to enhance shareholder value and close the discrepancy between our book value of $1.82 per share and our trading price."

When it comes to some companies, management's intentions are difficult to figure out. For other companies, however, the publication of management's intent can bring along the right kind of shareholder - one who is there because they would do the same if they were in charge, which results in a natural alignment of management and shareholder interests. This can result in fewer surprises, and a much more content shareholder group!

Disclosure: Author has a long position in shares of QCC


tscott said...

It's too bad they are only allowed one normal course issuer bid per year on the TSX. It's the best use of their cash. Oh well maybe they can do some block trades, a special dividend or wait until January 2011 for a new buyback.

Saj Karsan said...

Hi tscott,

They may also do a Substantial Issuer Bid...more on that in a future post.

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