OneMarket: ruthlessly excluded

You might be aware that Intelligent Investor runs ‘Dragons' Dens'. It's our term for the internal review process in which an analyst who wishes to upgrade a new stock presents the case to the analyst team.

You might also suspect that, as we all broadly classify ourselves as ‘value investors', we're usually in polite agreement.

Far from it. We disagree, sometimes vehemently. But while our dragons breathe fire, we try to ensure nobody gets singed.

Sometimes the disagreement is about a company's value – and thereby the price at which we should recommend it. Other times we disagree about a business's quality (which also affects the price you should pay).

As I'm a bit of an evangelist for ‘quality' these days, I usually push back against what I perceive to be weaker businesses.

Last week OneMarket (ASX: OMN) – the retail technology start-up demerged from the now-acquired Westfield Corporation – was raised as a potential investment idea for the InvestSMART Australian Small Companies Fund. With a market capitalisation of about $130m OneMarket is too small for us to recommend in Intelligent Investor, but it might be suitable for the fund.

The investment case

The case for OneMarket is simple enough. First, the natural shareholders of a small technology start-up are unlikely to be the same as the owners of property group Westfield. Many former Westfield holders might be expected to sell their tiny positions in OneMarket without regard to value. I have some sympathy with this idea – demerged stocks can be good hunting grounds for value.

Second, OneMarket listed with around US$160m in cash to fund technology development. With cash backing of around $2.10 a share, the share price of around $1.25 means it's trading at a 40% discount to that cash. Based on the Lowy family's excellent reputation, OneMarket might be a way to access good management at a discount.

It sounds compelling, but there are contrary arguments and, when the stock came up for discussion, I was very happy to make them. What follows is an edited version.

An exclusive club

Generally, I look for reasons to exclude rather than include stocks in my investable universe. A large majority of ASX-listed stocks are just not ‘investment grade' in my opinion, so any new idea should pass various tests. OneMarket fails four important ones for me:

1. It's a start-up. By definition OneMarket hasn't yet proven itself to have a sustainable business. I tend to exclude any business with revenue of less than, say, $50m (OneMarket generated $2m of revenue in 2017).

2. It's at a discount to cash backing. This is frequently a negative for me. The cash usually gets spent or otherwise frittered away, so the big discount that attracted you in the first place ends up disappearing. I'm rarely interested in asset plays.

3. It requires an uncertain amount of future capital. OneMarket is likely to raise additional equity before it achieves commercialisation, and losses tend to increase the closer a company gets to that stage (due to scale-up, marketing investment etc.).

4. The case rests largely on a ‘management story'. I'd argue that just because the Lowy family were successful at retail property development does not mean they'll be successful at retail technology.

Based on these four characteristics, OneMarket is about as far from ‘investment grade' as it's possible to be in my opinion. I doubt anyone can judge the odds of OneMarket rolling out products successfully at this early stage. Not only is the company outside my circle of competence, I believe it's outside everyone else's too.

Improve your odds

In my opinion, ruthless exclusion of stocks outside your circle of competence is likely to improve your investment odds.

This process of excluding stocks for many reasons means I miss plenty of winners – and I'm fine with that. I'm never looking for the next big thing; the risks of going from start-up to commercialisation over a 5-10 year period are too much for me. Instead I'm looking for underpriced quality businesses, which narrows my focus.

Of course, the fact OneMarket was proposed as an idea is evidence of different views around which stocks can be considered ‘investable'. I make no claim that my ‘ruthless exclusion' approach is the right way; just that it's the right way for me.

It's possible that OneMarket might find its way into an InvestSMART portfolio now or in the future. Every billion-dollar business was a start-up once.

However, for most investors, there's no need to bet on the next big thing. Get your lottery tickets from the newsagent and stick to underpriced quality in the sharemarket.

Disclosure: The author owns a small holding in OneMarket received in the demerger from Westfield.