Microequities boss Carlos Gil buys businesses not shares: repost from afr

Written by Vesna Poljak /Photo by Brook Mitchell

Carlos Gil knows that when a chief executive gets up at an annual meeting and says the macroeconomic environment was a problem for their company, that is a classic red flag for investors.

The Microequities Asset Management founder says “have no doubt, if that happens, you are across a mediocre business”.

“I don’t think I ever heard Steve Jobs speak about the US economy,” Gil says, “Great companies carve out their own destiny. Really talented management teams do that and mediocre teams are complacent and will swim in the excusatory river.”

Gil decided to be a fund manager when he was a 16-year-old student investing his savings of $2000 in a private hospital operator. He didn’t buy a car until he was 35 years old (a Hyundai) because he kept putting all his money into investments, he says, describing his philosophy as “frugal”.

Getting his first break at Ord Minnett, the fund manager has also worked as head of international equities for Banesto, part of Santander Group, in Spain before returning to Australia and starting Microequities. The biggest frustration working offshore, he says, was the lack of a thriving microcap environment. “I was homesick, I had most of my personal wealth tied up in Australian industrial microcaps and I couldn’t access research to invest. I decided to come back home and start an investment research house and I knew I would evolve that eventually into a funds management business.”

The Microequities flagship fund started in March 2009; it has recorded an average compound return of 26 per cent a year for the past eight years, after fees.

“The underlying growth dynamics of small companies are far better than large companies; more importantly as a value-based investor we believe there are greater pockets of market inefficiency. In Spain at least at the time, you just didn’t have the pool of industrial microcap companies whereas in Australia, we’re quite a unique market, roughly two-thirds of the ASX is made up of microcaps.”

The fund has a position in Smartpay Holdings, a payments processor targeting small businesses. “It’s really interesting, they’ve got a big share and are a significant player in New Zealand, and basically unknown in Australia because the regulatory barriers are different.” That could change with the imminent opening up of the market to providers that don’t hold a banking licence.

“Essentially in Australia they are now going to have a level playing field with the banks and we think this is going to be a seminal moment for their growth dynamics. It has a mature cash-cow business in New Zealand and that affords the management team the ability to take an aggressive growth strategy in Australia.”

Microequities owns more than 5 per cent of the Smartpay register. “They’ve had one arm tied behind their back,” Gil says. “Smartpay we think is going to have a number of significant competitive advantages in terms of their product offering.” It is also “highly undervalued,” he adds.
The fund manager has emerged a voice in the the battle for Hunter Hall International owning close to 5 per cent of the ethical investment manager’s shares. Gil trimmed his stake in January after founder Peter Hall’s exit but says his position is still profitable for the fund. He thinks the company is strongly positioned.

“The risk event wasn’t the exit of Peter Hall,” he explains. “It’s the manner in which Peter Hall has exited, the disorderly way and the sale mechanism that he’s instigated, and the chaotic nature of that exit that’s created havoc. But because we bought Hunter Hall at a very large discount to intrinsic value, even when we get a shock event like the one we’re facing we’re still doing well. We’re still making money on our Hunter Hall investment.”

His point is that a value doctrine affords investors protection from unforseen risks. “The fact that there was a heightened element of risk, that’s what we took into account,” in reducing the Hunter Hall position.

Gil sees investing as a “de facto business partnership” in the sense that “how well that business does will ultimately drive our investment outcomes”. Microequities’ average investment is five years, including sales forced through acquisitions. It specialises in small companies, but is value before growth. (Last year, Microequities exited three major investments through takeovers: Intecq via Tabcorp, ASG via a Japanese interest and Bigair via Superloop.)
“Whether we’re buying 1 per cent of a company or 20 per cent of a company it is tantamount to a business partnership. When you embrace that what that necessarily does is take you on a long term investment journey, because if you think about being proposed a business partnership you never contemplate entering that for six to 12 months.

“Whereas when people buy stocks they condense the investment horizon to six months, 12 months or even 24-month outlooks and I think that’s completely contrarian to their interests.”

He does not believe the market is efficient, and most companies are under- and over-valued at any time. “We’re obsessed with intrinsic value,” Gil says. “The market is a poor and ineffective valuer over the short to medium term.” For example, “you typically have a 40 per cent price range over a 12-month period,” spanning the high and low of a share price. “What I can tell you is intrinsic valuations are not fluctuating by 40 per cent over the course of 12 months.”

He likes Webjet, having owned it for a long time, and the bought M2 Communications when it was a $40 million market cap stock that went on to a massive merger with Vocus. Webjet “still has tremendous growth available to them”.