Dear Investor,

 DMXASF’s NAV increased 1.6% for the month of September, ahead of the ASX 200 Total Return Index which declined 2.8%. The broad market continues to be weak, with the smaller company sector continuing to bear the brunt of the sell-off. Smaller companies again underperformed, with the Emerging Companies Index falling 5.6%. As was the case in the prior month, most of our portfolio constituents fell in this broadly declining market. Two fresh takeover offers in September though offset decliners and helped drive a small positive return for the month.

Commentary

In a seasonally quiet month and a broadly weak market, most of our holdings declined over the month. Most impactful were an 18% decline in NZ-listed General Capital, and a 9% fall in RPMGlobal. Each for no particular reason, and handing back some prior gains. Pleasingly, RPMGlobal has in early October upgraded guidance for both revenue and profit, though not surprisingly in this market, with a muted market response.

More positively, Academies Australia and Reckon each recovered 11%, while Earlypay and SOCO Corp each rose around 20%. Mostly, we benefited from takeover offers for Cirrus Networks (up 43%) and less impactfully, Diverger (up 15%). We’ve emphasised in recent months the particularly attractive levels whole swaths of the market have fallen to. As highlighted in the DMX Capital Partners (DMXCP) report, many companies have been trading at valuations reminiscent of the Global Financial Crisis market trough – levels from which exceptional returns were subsequently recorded. Not surprisingly therefore, the market continues to get picked over by private equity and industry players seeking to snatch a bargain. Again, as highlighted in the DMXCP report, what has been surprising though has been how quick and prepared to deal many Boards and substantial shareholders have been. Fortunately, in some instances key shareholders have been able to drive improved outcomes.

Current portfolio holdings subject to takeover include Cirrus Networks, DDH1, Energy One, and now Diverger. Cirrus Networks, DDH1 and Diverger have been targeted by industry peers seeking to benefit from scale and synergies (together with attractive acquisition multiples), whereas Energy One has been private equity prey. In the case of Cirrus, an initial bid was improved by nearly 20% in order to secure broader support from key shareholders. We wouldn’t have supported the initial bid, but at the improved price and in the absence of a higher competing offer (which was initially possible but looking less likely as time rolls on), we are supportive. While the price isn’t quite top dollar, it represents a ~80% return on our investment and would free up capital for us to rotate into other more interestingly priced opportunities.

DDH1 has been disappointing, as the company is being effectively merged into a larger operator on terms that – in our estimation – substantially undervalue the business. This one’s a done deal now with shareholders voting in favour (though we voted against the deal), and crucially, its largest holdings supporting the transaction. The company’s largest holder has been legendary value investor Howard Marks’ firm, Oaktree. Given their value-oriented philosophy and the terms they’ve agreed to here, we’ve found this somewhat perplexing. We’ll receive some cash and mostly scrip in Perenti which we’ll continue to research and ruminate on before deciding how we’ll proceed.

Energy One remains subject to exclusive acquirer due diligence with US-based software-specialist private equity firm STG Partners. This one’s a pure cash offer, so cleaner in that sense. But the price is too low. Key holder and now-former director Vaughan Busby has publicly rejected the offer. At the price offered, we’re hoping for the deal to either fail, or for a much-improved bid. With DD having dragged out for some time, we expect to know one way or the other fairly soon.

Finally, Diverger’s Board and its largest (31%) shareholder – Hub24 – have agreed to be acquired by fellow ASX-listed Count. You know you’ve done a bad deal when your acquirer’s stock pops 10% on the announcement. They’re supposed to go down. It’s still early days for this deal and we’re hoping for an outcome more like that for Cirrus than for DDH1. The DMXCP report covers this extensively, with commentary attached here as an Appendix. In short though, we control a little over 5% of Diverger’s shares outstanding, and having recently become a substantial shareholder, have received a number of approaches from other shareholders unhappy with either the deal or the price offered. With a groundswell of resistance to Count’s first offer, together with the low price offered in an absolute sense as well as the even lower price when the very material and obvious synergies are taken into account, we’re hopeful either the offer will be improved materially, a competing bid emerges, or the deal as proposed fails. We’d be happy with any of these outcomes.

Summary

We’ve been managing reasonably well through the current down-leg of the broader and particularly smaller companies sector. Most of our portfolio has fallen in sympathy, but takeover offers have helped prop us up. We’re working very carefully to trim and potentially exit the least prospective of our portfolio holdings in order to add to and initiate new positions in very attractively priced quality businesses. Where takeover offers fall short of our expectations around reasonable valuation, we’re not afraid to reject a bid or to attempt to work constructively to help secure a more appropriate price and terms. There’s nothing wrong with takeover bids failing, and we believe investors shouldn’t be too concerned with missing out on a quick 10-20% but to instead remain focused on a company’s underlying business and the potential rewards to shareholders from long-term ownership.